Fed buying reels in agency spreads; take profits, Barclays says; survey sees issuance growing

By Kenneth Lim

Boston, July 31 - Agency spreads made a sharp move inwards Friday as the Federal Reserve Bank of New York bought up $2 billion of paper as part of its open-market operations.

Two-year bullet spreads were in by about 3 to 3.5 basis points, while five-years were in about 2.5 bps and seven-years and 10-years narrowed by about 2 bps, an agency trader said.

"Spreads tightened quite a bit today," the trader said. "Swaps were in 1 to 2 bps across the curve, callables on the whole were better than swaps."

The trader added that rates investors are going further out on the yield curve as the curve flattens.

"In the Treasury curve we're seeing a flattening right now," the trader said.

"They obviously can't lower the interest rate any lower, so the front end lost some ground, but with that people were able to go out on the curve and try to earn money on the roll-down effect. If you hold a 10-year for one year, you can sell it at nine-year level, and the difference between the 10-year and nine-year is 10 to 15 bps, and that's lot of money."

Fed boosts demand

The Fed said Friday that it bought $2.151 billion of agency paper on the open market, about 50% of the amount submitted. The securities mature in 2013, 2014, 2015 and 2016.

"It's one of the reasons for the tightening," the trader said.

In a research note, Cantor Fitzgerald chief fixed income rates strategist George Goncalves said the three- to five-year sector has generally benefited from the Fed purchases.

"We could see the overall sector staying well bid so long as risk markets and spreads stay tight," he wrote.

Little upside

Barclays Capital agency analysts Rajiv Setia and James Ma wrote in a note that "there is little upside potential in agencies and investors should look to selectively take profits, selling to the Fed where possible."

The analysts pointed out that the richness of the agency market could be behind reduced participation of fund managers in the primary market, and could even dull the attractiveness for the cash-rich domestic banks.

"One primary reason, particularly for indexed funds, may be that as agency-Treasury spreads approach the low teens, the possibility of earning negative excess returns becomes almost certain," the analysts wrote. "With anxiety about where spreads might settle in a post-Fed world likely to rise by the end of 3Q, the likelihood of experiencing 5 bp or more in spread widening is fairly high, especially in a rising rate environment."

But if investor demand is weak, that might force agency issuers to give a "hefty new issue concession" on new offerings.

"One measure of this - the most recent 3-year agency bullet deal [by Federal Home Loan Banks] priced at T+35bp a week ago and is already 11bp richer," the analysts said.

Issuance to grow, spreads flat, survey says

The latest quarterly Government Securities Issuance and Rates Forecast survey by the Securities Industry and Financial Markets Association shows that participants expect agency issuance to grow in the third quarter and that spreads will stay flat.

The survey forecasted total gross note issuance of $333 billion in the third quarter by the four largest federal agencies - Fannie Mae, Freddie Mac, FHLB and Federal Farm Credit Banks Funding Corp. - compared to $120 billion in the second quarter.

FHLB is expected to account for almost 40% of that volume, the survey report said.

Respondents also expect agency-to-Treasury spreads to remain unchanged during the quarter.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.