Agencies narrow as Treasuries retreat; volumes flat; Fannie Mae could sell at front end

By Kenneth Lim

Boston, Oct. 26 - Agency spreads closed flat to a touch tighter on Tuesday amid a drop in Treasury prices.

Bullet spreads narrowed slightly as Treasury prices declined as investors set up for auctions in the coming days. Spreads came in by about 2 basis points in the two-year sector, 1.5 bps in three-years and 2 bps to 2.5 bps in 10-year and longer maturities.

"Spreads are in on the day," an agency trader said.

Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson & Co., said the market remained quiet.

"Today was actually a fairly quiet day," she said. "We are lower in yields, and people are basically looking to buy the dips, but right now there is a lot of uncertainty surrounding the market."

Investors had been positive about two weeks ago as weak economic data and remarks by Federal Reserve officials bolstered expectations that the central bank would buy more government debt to try and raise inflation.

But that optimism has now been tempered by uncertainty about the details and impact of any Fed easing.

"At first [quantitative easing 2] was viewed very, very positively, but now there's a lot of concern about the inflationary impact that's going to have," Hurley said.

Yields nevertheless remain low from a historical perspective, and that has been hurting callable volumes.

"We've seen a lot less issuance than what we have in previous days," Hurley said. "Most of the issuance does seem to be in step-ups...I would have to say it's the low yielding rate environment that we're in that is just limiting demand."

Fannie Mae ahead

Fannie Mae could announce a front-end offering of Benchmark Notes on Wednesday as a calendar window opens, the trader said.

"Probably a new three-year, but it could also be a reopening of the two-year," the trader said.

The market is not expecting Fannie Mae to issue five-year notes.

Beyond the potential supply, the market has its eyes on the coming week's Fed meeting, from which investors widely expect the next round of quantitative easing to be announced.

"People are going to be fairly flat for it," Hurley said. "But I think there are buyers on the price dips out there because overall people still think that the economy is weak and inflation is not going to be a problem probably for the next two to three years at least."

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