Agency spreads narrow as investors remain confident; Freddie Mac could announce five-years

By Kenneth Lim

Boston, Jan. 4 - Agency spreads tightened on the first day of trading in 2010 as investors continued to express confidence in the federal government's support for the market.

Meanwhile, the Street expects Freddie Mac to start the year's primary bullet market on Tuesday with an announcement of a five-year offering.

Bullet spreads were about 1 to 2 basis points tighter across the yield curve, an agency trader said.

Spreads in the 10-year sector showed some slowdown from the previous week's tightening, which was in turn prompted by the Treasury's decision on Christmas Eve to uncap a funding lifeline for Fannie Mae and Freddie Mac.

"Ten-years didn't really tighten up any more today, but the rest [five-years and later sectors] did tighten up about 2 bps today," the trader said.

The market could give up some of the gains made over the past week, but currently it still looks strong, the trader added.

"Not as of yet, but we will," the trader said.

The market saw only light volume following a likewise quiet end to 2009.

"For the most part it was a little bit slower," the trader said. "The end of December was pretty busy up until Thursday. We've carried over from Thursday to today. It's not that active today, although there was a lot more printing in terms of underwriting."

Callable supply picked up again after thinning out on Dec. 31.

"We had quite a few issues printing today, especially compared to last Thursday, because it's the new year and you don't have to worry about funding," the trader said. "We did see a fair amount of underwriting today...we cleared probably 60% of what we wrote today."

Freddie Mac could target five-years

Freddie Mac could announce a new offering of five-year Reference Notes on Tuesday, the trader said.

"Five-years would make sense," the trader said. "That's a pivot point for them. There's quite a bit of demand in the five-year area."

Mark Noble, head of agency at MF Global, wrote in a note on Monday that Freddie Mac will probably take advantage of rich Libor valuations in the five-year sector. Five-year spreads versus Libor were near the 2009 lows at 15 bps in the last week of December and are currently around 9 bps under Libor, he wrote.

But Noble added that a new three-year offering could also be possible.

"Freddie Mac may instead opt to issue a new issue 3-year as Freddie has a fair amount of competing cheaper supply coming to the market," Noble wrote.

Supply picture murky

The trader said the primary market is still an unanswered question at this moment.

"It's real tough to call," the trader said. "I think supply this year is still going to be robust from an agency standpoint."

The whole fixed income universe could also be affected by additional government spending if a health care bill is passed.

"Obviously we have a lot of debt we have to issue," the trader said. "If the health care bill passes, how much more debt do we have to issue and how much more negatively will people view our debt? I think the amount of supply coming to agencies will be approximately 85% to 75% of this past year's. With health care being passed it could be somewhat higher."

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