Bullet agency spreads contract amid tighter swaps, small Freddie Mac issue, month-end buying

By Kenneth Lim

Boston, July 29 - Bullet agency spreads tightened slightly on Wednesday as swaps contracted and Freddie Mac sold a smaller than expected amount of Reference Notes.

Two- and three-year spreads were 1 to 3 basis points narrower, while five-year paper traded 2 to 3 bps tighter, an agency trader said.

"In general spreads continue to tighten in our market," the trader said. "We've seen better buying in general with a back-up in rates as well as, as we get closer to month-end needs...also swaps were tighter as well, so we were following swaps."

Freddie Mac reopened a series of 4.125% Reference Notes due Dec. 21, 2012 on Wednesday, selling $1 billion through a private placement run by Barclays Capital Inc, according to a press release.

A Freddie Mac spokesperson said the notes were sold at par.

The market had been expecting a deal in the $3 billion to $4 billion range, and the smaller-than-expected offering helped to pull spreads inwards.

"There was the Freddie Mac reopening of a December 2012 Reference Notes, which basically any supply concession that had been built in was removed," the trader said.

Treasuries in the spotlight

The agency market will be closely watching the final Treasury auction for this week on Thursday, with $28 billion of seven-year notes in the pipeline, the trader said.

"We got the seven-year auction in Treasuries tomorrow, which will probably dominate the rest of the week from a yield standpoint," the trader said. "If we see softer [Treasury] yields, you'll see spreads hanging in there. If you get some bounce off of these [price] levels in Treasuries...I would expect some profit taking."

The effect of the Treasury auction will be guiding the agency market together with the expected month-end buying, the trader said.

"Depending on how the auction is received, if it goes decent, you're pretty much left with the relief rally in month-end buying," the trader said.

Spreads too narrow

A fixed-income strategist said the tight agency market is now a "very dull, low-spread world" that lacks excitement.

"Agencies versus swaps are very rich in the front end," the strategist said. "They've come off their highs, but they're still very rich."

The Federal Reserve's buying of agency securities is keeping spreads artificially narrow, and current uncertainty about the supply situation is not likely to clear up until the end of the year, the strategist said.

"I don't think it's going to change any time soon," the strategist said of the richness. "Until the end of the year."

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