Agency spreads tighten as fears ease; FHLB could sell new three-years, reopen five-years

By Kenneth Lim

Boston, Dec. 7 - Agency spreads narrowed on Monday and callable issuance remained strong as concerns about higher interest rates eased.

On the supply side, Federal Home Loan Banks is expected to announce an offering of new three-year notes or reopen an existing five-year series.

Bullet spreads tightened by 2 to 3 basis points in the 10-year sector on Monday, said Christopher White, senior vice president of fixed income sales and trading at Moors & Cabot Capital Markets.

"We saw what I would consider robust buying for the day," he said. "We also saw a fair amount of demand for off-the-run Home Loans and [Federal Farm Credit Banks], especially in the 2015 and 2016 sectors. [There was] better buying in five-years, the belly of the curve."

The middle of the curve attracted investors who were looking for better returns, he said.

"We've seen a big back-up in yields, 10 to 12 bps in that part of the curve, and people were looking for yield right there," White said, adding: "You continue to see a fair amount of money market cash going into 18-month bullets and a lot of structured deals with say a one-year call and a two-year step-up."

Callable issuance continued at a brisk pace, he said.

"Issuance is still very, very large," he said. "It's more money managers, people looking for a bit of absolute yield. You saw probably 35 different structures today printed. Small structures, mostly by the regionals."

Post-data action

Some of the tightening on Monday was also a reaction to non-farm payroll figures just before the weekend that showed slower-than-expected job losses.

Fed Fund futures had indicated higher fears of a rise in interest rates on Friday when the payroll data was released, White noted.

"The Fed Fund futures, after the unemployment numbers were trading with a 68% probability that Fed Funds will be at 50 bps in June 2010," he said. "That's up from 40% pre non-farm payroll."

But the market was less worried about rising rates on Monday, especially after Federal Reserve chairman Ben Bernanke sounded a note of caution on the strength of the economy.

"What that tells me is he's not yet at a place where he's going to start taking money out of the system," White said.

FHLB around the corner

FHLB on Tuesday could announce an offering of new three-year Global Notes or reopen its existing 5.125% notes due August 2014, White said.

For the rest of the market, the week ahead could be affected by swaps, he said.

"It depends on swaps," White said. "We've seen two-year swaps come in from two weeks ago from 40 bps to 36 bps, but versus swaps agencies have tightened. So do I see spreads widening? No. There still seems to be a lot of appetite for any yield on the curve right now."

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