Agency spreads loosen as investors await Fed meeting, data; Freddie Mac offering awaited

By Kenneth Lim

Boston, Nov. 2 - Bullet agency spreads widened on Monday with swaps as investors remained wary of commitment.

Freddie Mac could announce an offering of three-year Reference notes on Wednesday and a deal would likely enjoy strong interest from investors, market sources said.

Bullet spreads were about 2 to 3 basis points wider across the yield curve on Monday, an agency trader said.

"Agencies have been tracking swaps, but volumes are really, really thin," the trader said.

Spreads have been stuck in a range over the past month, and Monday's widening was simply a correction after spreads tightened earlier in the previous week, the trader added.

"It's just the pendulum swinging back out, but it's going to come back," the trader said. "There's no real direction in the market right now. Valuations are really rich in agencies. Investors are still buying because the little bit of spread we have is still better than nothing, but it's really, really rich especially at the front end."

Callable issuance was again busy on Monday after a slow Friday as investors continued to seek higher short-term yields.

"I think there's a bit more doubt in the strength of the economic recovery right now," the trader said. "What that means is there's more confidence that rates will not be raised so soon, so callables remain very attractive to a lot of investors at this time."

Wait-and-see week

The week will likely be plagued by thin volumes, said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson & Co.

"This week we're in a lot of the waiting game, waiting for the Fed, waiting for non-farm payrolls," she said.

The Federal Reserve's Federal Open Market Committee is meeting on Tuesday and Wednesday, while non-farm payrolls and unemployment figures will be released on Friday. But Hurley does not expect any major surprises.

On the economic front, the Fed will likely keep its language on the state of the economy and interest rates mostly unchanged, she said.

"The rebound we've seen in the economy is very limited at best and all of it has been driven by the government stimulus," Hurley said. "You take away the punch bowl, so to speak, and the economy is just going to fall flat on its face."

Hurley does not believe rates will change soon.

"At some point they're going to tighten, unquestionably, but they can't do that yet," she said. "Even the warning of higher rates isn't anywhere close."

Specific to the existing outright agency coupon purchase program, the Fed will also most probably stick to its current intention of gradually phasing out the program through the first quarter of 2010, Hurley added.

"I don't think they're going to make any changes."

Freddie Mac in waiting

The market will look to Freddie Mac for some potential supply, with an announcement on Reference Notes issuance slated on Wednesday.

"We don't really call how much financing they need, but I would expect that - all of the deals that have come recently have gotten good demand - and I don't expect anything different," Hurley said.

The agency trader said Freddie Mac could come with a deal in the three-year sector because funding levels are favorable there, but some investors are also predicting a five-year deal.

"I've heard five-years," the trader said. "I think that's possible. They haven't done any new five-years since July; it was a reopening. So they could very well do something there, but I'm betting on three-years just because the curve is more favorable in that sector."

The deal could lead to some spread widening on Wednesday, but the impact will likely be limited, the trader said.

"You'll usually see a little bit of widening just because some people are going to be switching, but most of the deals nowadays are pretty small, so it's not like supply is changing that much," the trader said. "You also have the Fed supporting the entire market, so we're only going to see minimal movements."

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