Agencies widen at longer end as Fed fuels inflation fears; Freddie Mac may skip issuance

By Kenneth Lim

Boston, Dec. 14 - Agency spreads continued to ease out Tuesday amid selling at the longer end of the yield curve following the Federal Reserve's decision to maintain its quantitative easing policy.

Bullet spreads closed flat in the two-year sector, while widening by 0.5 to 1 basis point in three-year and longer maturities.

"It's been a choppy day as you'd expect given how Treasuries have done," said Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial. "We did see some buying mostly in the two- to three-year sectors."

Callable issuance remained light as the markets slow down for the end of the year.

"It's been spotty," Riley said. "We're drawn down to the end of the year and most of the agencies don't want to issue that much more. All of the new issues now have January settlement dates, so people are looking forward to it quieting down."

Fed rocks the boat

The Federal Open Market Committee said Tuesday that it will maintain its existing policy of buying $600 billion of Treasuries as well as reinvesting maturing non-Treasury debt on its portfolio into Treasuries.

The central bank's policymaking body also kept the target Federal Funds rate at zero to 0.25% for an "extended period."

The language from the FOMC's statement did not come as a surprise, which made the day's price movements unexpected, Riley said.

"The Fed announcement was all that we expected, so I don't really know why," he said.

Some investors may have been hoping for the Fed to address fears about inflation in the recent light of some positive economic data as well as a proposed tax deal in Washington, Riley said. That would explain the increased volatility in longer maturities.

"There are a lot of cross currents," Riley said. "The longer end of the market was obviously a little more choppy."

With the back-up in rates, outright rate investors provided most of the activity for the day as they sought out higher yields.

"People were dipping their toes in the water," Riley said. "There was good flow from real money buyers, not fast money buyers."

Freddie Mac ahead

Freddie Mac is not expected to come with a big offering of Reference Notes on Wednesday's calendar slot, Riley said.

"I don't know if it really matters," he said. "We could see one more issue, but I don't think they need it. Leading up to it with the cancelation last week [by Federal Home Loan Banks] they might just cancel as well."

The agency market has been slowing down a little earlier than usual, and market participants could simply be looking for a breather after a volatile fourth quarter.

"I would suspect that by early next week it will really start to slow down and then it will be really quiet in the end of the year," Riley said. "People are usually scrambling to get a little more done by the end of the year, but this year it seems like people are glad to get a break."

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