Agency spreads unchanged as snowstorm thins desks; Freddie Mac skips Reference Notes sale

By Kenneth Lim

Boston, Feb. 10 - Agency spreads closed flat on a quiet Wednesday as a skipped Freddie Mac issuance and bad weather in New York put a damper on market activity.

The Federal Reserve Bank of New York announced a purchase operation at the front end of the yield curve for Friday, while Fed chairman Ben Bernanke said the central bank does not expect to sell its agency debt holdings anytime soon.

Spreads ended mostly unchanged on the day, although the front end performed slightly better with the announcement of the Fed operation and Freddie Mac saying it will not offer Reference Notes this month.

"Freddie Mac passed, which was a little bit of a surprise because some people were expecting two or three years; so, initially there was a touch of tightening at the front end," said Michael Skinner, an agency trader at Wall Street Access.

An auction of 10-year Treasury notes was disappointing, but it was enough of a distraction for fixed-income investors in a day when there were no events to spark excitement in agencies, he added.

"Treasuries were the highlight of the day," Skinner said. "Agencies were somewhat at a standstill."

Trading volumes thinned out as snow piled up in New York, with many desks shortening their day to accommodate the weather, Skinner said.

"It was pretty quiet," he said. "All our New York dealers were shut down pretty early."

Even callable issuance and trading took a breather from its usually robust pace.

"There was no callable action," Skinner said.

Fed to buy short-term notes

The Fed said it will buy agency notes due February 2011 to January 2012 on Friday as part of its outright coupon purchase program.

The Fed has already bought about $165 billion of notes under the $175 billion program, which will end by March 31.

An agency analyst said the Fed may not use the full $175 billion allowed under the program, but the market will probably not be concerned.

"At this rate they're going to buy just over $1.5 billion per week over the next six or seven weeks, so if they keep at this pace and they slow down the buybacks like they said they would, they might actually not get to $175 billion," the analyst said. "But I don't think it's going to be a big deal.

"They've been careful to say that the buyback is up to $175 billion, so they've hinted before that they're perfectly OK with not going all the way to $175 billion."

Bernanke outlines exit strategy

In a written testimony released Wednesday, Bernanke said he does not expect the Fed to sell the agency notes purchased under the buying program anytime soon.

"I currently do not anticipate that the Federal Reserve will sell any of its security holdings in the near term, at least until after policy tightening has gotten under way and the economy is clearly in a sustainable recovery," he said.

The Fed will instead let its agency debt and mortgage-backed securities run off as they mature or are prepaid in the meantime, he said. But he allowed that asset sales might occur in the future if the Fed determines that "financial tightening is warranted."

The analyst said the Fed chairman's statement reaffirmed the central bank's commitment to holding interest rates at a low level for awhile. Investors would also be reassured that the Fed is aware of the market implications of selling its portfolio.

"The good news is the Fed is thinking about an exit strategy and they seem to recognize the key issues regarding that exit," the analyst said.

But the lack of guidance on timing may keep the markets rangebound, the analyst said.

"I think the one thing that the market would have really liked to have gotten was some mention of the timing of their exit strategy, which he didn't touch on," the analyst said. "So that's a big uncertainty that's going to stay with us for a while, and it's going to put pressure on longer term spreads.

"There's also concern that the longer they keep the stimulus policies alive, the higher the risk of a sharp hike in rates when they do change policy."

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