Agency spreads widen as market anticipates front-end Fannie Mae supply; budget underwhelms

By Kenneth Lim

Boston, Feb. 1 - Agency spreads eased out slightly on Monday as investors prepared for possible supply at the short end of the yield curve from Fannie Mae, while reaction to the White House budget proposal was muted.

Bullet spreads widened a little across the yield curve, an agency trader said. Two- to five-year spreads moved out by about 2 basis points, while in the 10-year sector spreads softened by about 1 bp.

"Spreads are leaking a tad wider," the trader said.

Callable issuance remained healthy, although volumes paled in comparison to Friday.

"Friday was a better day for callables, larger deal sizes," the trader said. "Today was a typical day. [There were] only about 40 or so new issues and a couple of decent-sized deals."

Trading activity was also slow to pick up after the weekend lull.

"It's been a pretty quiet Monday if you ask me," the trader said. "We've just been doing kind of our same-old, same-old."

Fannie Mae in pipeline

Fannie Mae could announce new two- or five-year Benchmark Notes on Tuesday as part of a calendar offering, the trader added.

The Street's expectations of supply in those sectors appeared to cause weakness at the front end of the curve.

"That's put pressure on front-end spreads," the trader said. "I think there's just better sellers out there."

But Monday's weakness could provide an opportunity for some investors to find bargains later in the week.

"I think it's just kind of setting up for some buying tomorrow," the trader said.

Market brushes aside budget

The market was mostly unmoved by the release on Monday of the White House budget proposal, the trader said.

President Barack Obama on Monday asked Congress to approve a $3.83 trillion budget for the coming year that would raise the budget deficit to $1.56 trillion. The administration expects Fannie Mae and Freddie Mac to receive about $153 billion in funding from the Treasury by September 2011 and to repay about $7 billion per year after that, budget document said.

The budget proposal did not lay out a plan for Fannie Mae and Freddie Mac, which are under federal conservatorship, as expected. Instead, the proposal said only that "the administration continues to monitor the situation of the GSEs closely and will continue to provide updates on considerations for longer term reform of Fannie Mae and Freddie Mac as appropriate."

The trader said the lack of details about the future of the two housing agencies was underwhelming.

"It's kind of like much of the same," the trader said. "We've been hearing this over and over again, so there's no new news."

But the market also seemed to be surprisingly calm about the size of the proposed budget.

"It was pretty shocking to me," the trader said. "It seems like spread products and Treasuries should be in a lot worse shape just based on supply. I don't know; it seems like kind of a muted reaction."

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