Agency spreads widen at front end, hold firm further out as Fed buys $1.079 billion of paper

By Kenneth Lim

Boston, Dec. 4 - The long end of the agency yield curve continued to outperform on Friday as the Federal Reserve Bank of New York provided support in the four- to seven-year sectors.

Bullet spreads were slightly wider at the short end, an agency trader said.

"Spreads were modestly wider, like 0.5 to 1 basis point wider on the short end," the trader said. "The long end is unchanged even though swaps are out 1 to 2 bps."

Trading volumes were slim, but the week in general has been quieter than usual for the agency market, the trader said.

"We had a lot of callable issuance, but this week there didn't seem to be as much interest in agencies as last week," the trader said. "This week it was more people trying to sell supra sovereigns to buy agencies. That was the trade this week."

Over the week, spreads were mostly flat nearer to the front end.

"On the week, five-years closed at 23 bps," the trader said. "They started the week at 22 bps. The long end's actually tighter. Sevens and 10s are a little tighter."

Fed buys five-years

The Fed on Friday bought $1.079 billion of four- to seven-year agency notes as part of its outright agency coupon purchase program.

The amount purchased was 31.4% of the $3.435 billion of notes tendered.

The trader said the operation went as expected, noting that the percentage of tendered notes that the Fed bought was comparable to recent purchases. The Fed bought 35% of the tendered amount the previous week.

"They bought back around 35%, which was in line," the trader said.

The targeted sectors of the curve found some support because of the Fed action, the trader added.

More flattening ahead

The week ahead will hinge on how the Treasury market does, the trader said. If rates in general go up, there should be more interest in agencies, which continue to offer an attractive pick-up over Treasuries.

"We're a little directional here," the trader said. "If the [Treasury] market rallies, we'll see spreads continue to hang in...Higher yields bring convexity needs and put pressure on swap spreads, which will push agency spreads out as well."

The short end of the curve, which lagged the longer-dated paper during the week, has opportunities to outperform, the trader added. But the long end should continue to narrow relative to the front of the curve.

"The slightly higher rates on the long end have supported buying," the trader said. "Some of the long end you can get close to 5%, 4.5%, and that would bring in buyers."

On the supply side, callable issuance should be strong early in the coming week, while Federal Home Loan Banks could bring a three-year offering of Global Notes on Dec. 8, the trader said.

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