Agency spreads follow spreads tighter on flight to safety; Fed eyes longer-term agency bonds

By Kenneth Lim

Boston, Sept. 24 - Agency spreads followed spreads tighter on Thursday amid a broad flight to safety, while Freddie Mac's reopened three-year notes narrowed even with the additional supply.

Meanwhile, the Federal Reserve Bank of New York said it will buy agency debt at tenors of seven years and beyond, although market sources said the announcement was not a major factor for investors.

Bullet spreads were 1.5 to 3 basis points narrower across the yield curve on Thursday, with the biggest tightening coming in the five-year sector, an agency trader said.

"Everything's a little bit tighter today," the agency trader said. "It's mostly driven by swap spreads coming in."

The spread tightening came hand in hand with a strong auction of seven-year Treasuries. The U.S. government on Thursday sold $29 billion of seven-year notes at a high bid-to-cover ratio of 2.79.

One dealer said investors had been waiting earlier in the week to make a move, and Thursday's sharp drop in the equity markets was a catalyst.

"Investors were just waiting for something to happen, and today just happened to be the day when they decided equities were due for a correction and investors started to come back to lower risk sectors," the dealer said. "All the fixed income sectors are better today."

The agency market is also getting a boost from accounts that are preparing for the end of the quarter, the dealer said.

"People are looking for short-term, low-risk places to put their money with the quarter coming to an end, and a lot of them come to agencies for that," the dealer said.

Freddie Mac sells three-years

Freddie Mac on Thursday priced a $1 billion reopening of 2.125% Reference Notes due Sept. 21, 2012 at 101.333583 through an auction.

That price represents at stop yield of 1.665%, which was about 21 bps over Treasuries at the time, according to a Freddie Mac announcement.

There are $6.5 billion outstanding of the notes after the offering.

The notes tightened by 1.5 bps on Thursday, the agency trader said.

"They seemed to all go pretty well received," the trader said. "Usually on a reopening they have a tendency to go relatively well because it gives traders a chance to cover any shorts if they're hedged. And it wasn't that big of an upsize, it was only $1 billion, so it was taken up pretty quickly."

Fed to target longer-term paper

The Fed plans to buy seven- to 23-year agency paper on Friday as part of its weekly open-market operations, according to the central bank.

The securities targets mature in 2016, 2017, 2018, 2019, 2029, 2030, 2031 and 2032.

The Fed announcement helped to pull in spreads farther out on the yield curve on Thursday, but the impact was not a major driver of prices, the dealer said.

"It helped spreads to tighten, but I don't think this was the major factor," the dealer said. "Most of the market's in five-year and shorter sectors anyway. They don't usually buy a lot in these sectors, so I'm not expecting anything big tomorrow."

The Fed also announced earlier in the week that it plans to slowly wind down its purchasing program over a longer period of time - the program will end at the end of the first quarter of 2010 now instead of the end of 2009. But given that the Fed's buying pace had not been brisk enough to bring it up to its target of $200 billion by end-2009 anyway, the announcement was not a big surprise, the dealer added.

"It's just more of the same, personally," the dealer said. "Maybe it helped a little because it took away some uncertainty, but honestly nobody was really surprised."

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