Agency spreads tighten at front end on Dubai fears; Freddie Mac talks three-year bullets

By Kenneth Lim

Boston, Nov. 30 - Agency spreads tightened at the front end of the yield curve on Monday as investors sought quality amid concerns about Dubai World's health.

Freddie Mac announced a new offering of three-year Reference Notes at price talk that appeared to have been tightened late in the day.

Bullet spreads came in by about 1 to 1.5 basis points in the two- to three-year sector on Monday, an agency trader said.

"There's been strong buying in the two- to three-year sectors," the trader said.

Demand for callables, and step-ups in particular, remained strong, but issuance slowed down from the previous week, when Federal Farm Credit Banks sought to cover its refunding needs in anticipation of calling its existing structured paper, the trader said.

"Folks are less inclined to grab that since it rallied so much," the trader said.

The Federal Reserve Bank of New York on Monday also announced that it will be testing reverse repurchase agreement mechanisms in the coming weeks. Reverse repos have been mentioned by the Fed as a possible tool to help it reduce its portfolio of Treasuries, agency debt and agency mortgage-backed securities that were bought through its outright purchase program.

The news was mostly ignored by the market, the trader said.

"I think it's priced in," the trader said. "It's the very, very tip of the iceberg, but the market's been prepared for it."

Looking ahead, Fannie Mae is in line to announce on Wednesday whether it will offer new Benchmark Notes. The agency reopened $1 billion of its 1% notes due Nov. 23, 2011 on Nov. 18 and has another calendar announcement date on Dec. 16.

"They could pass because they have another slot in mid-December," the trader said. "But if they want to issue something I think it will be a two-year issue."

Dubai boost

Agencies got a boost from concerns over Dubai World, the Dubai state-owned conglomerate that has fueled speculation of default because of delayed debt payments.

"We were outperforming swaps," the trader said. "Swaps were maybe 1 to 2 bps out versus Treasuries on some of the concerns over the Dubai story. Agencies captured a little bit of that flight to quality."

Dubai World has said it is in talks with banks to restructure $26 billion of debt. The central bank of the United Arab Emirates on Sunday offered new funding for local banks but stopped short of providing explicit support for Dubai. A Dubai official on Monday said the government does not see itself as the guarantor of Dubai World's debt.

Freddie Mac tightens talk

Freddie Mac tightened price talk on its offering of new three-year Reference Notes by about a half-point to about 31 bps over Treasuries, the trader said.

Initial price talk on the deal, which will price Tuesday, was set at 31.5 bps over Treasuries.

The size of the deal has not been set, but it is expected to be benchmark size, or at least $3 billion.

Barclays Capital, Inc., Banc of America Securities LLC and JPMorgan are the bookrunners.

The deal targets a sector that has attracted investors recently, the trader said.

"It's valued very well," the trader said. "I think there's good demand. There's been good demand for that sector and good buying in the last week or so."

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