Agency spreads narrow as Fed targets five-years for purchase; FHLB's new three-years tighten

By Kenneth Lim

Boston, Feb. 18 - Agency spreads tightened slightly on Thursday as the Federal Reserve Bank of New York announced a purchase operation around the five-year sector, while Federal Home Loan Banks' new three-year Global Notes met with a positive response.

Two-, three- and 10-year bullet spreads narrowed by about 1 basis point, said Mark Noble, head of agency trading at MF Global. Five-years had the strongest performance of the day with on-the-run spreads narrowing by about 2 bps while yields on off-the-run five-year paper moved as much as 3 bps closer to Treasuries.

"All spreads are tighter," Noble said. "We definitely outperformed swaps."

Callable issuance also increased on Thursday on the back of a drop in Treasury prices, which nudged yields higher.

"There was definitely more callable issuance," Noble said. "It's the fact that you're getting more attractive coupon levels again."

FHLB tightens on debut

FHLB's new 1.625% Global Notes due March 2013 narrowed slightly to a spread of about 25.5 bps bid after pricing at 26 bps over Treasuries, Noble said.

The deal priced earlier in the day following price talk at a spread of 27 bps over Treasuries. The notes sold at 99.818 to yield 1.686%.

JPMorgan, Morgan Stanley and UBS Securities were the lead managers.

"Obviously they tightened up the pricing into the deal, instead of pricing at the wider end of the range," Noble said. "It held its own, closed about 1 bp tighter on a Libor level...It came at 26 bps, opened up at 25.5 bps, 25 bps, and pretty much stayed there all day long."

Secondary trading was thin in the new paper, which received strong interest during the marketing period.

"The new three-year FHLBank Global was substantially oversold a few hours after its announcement yesterday," according to a statement from FHLB. "Ongoing demand for Aaa paper, light competing issuance, and fair pricing contributed to this success. As in the December three-year Global, central banks showed strong interest, recording 27% of sales."

Fund managers formed the biggest group of investors, taking 47% of the notes offered, followed by central banks, FHLB said. Insurance and pension funds bought 10% of the offering.

In terms of regions, domestic investors received 66% of the new notes. Asian investors took 7%, followed by Europe with 5%.

Fed to buy at belly

The Fed plans to buy agency notes due March 2014 to July 2016 on Friday, according to an announcement by the central bank.

Although the news was not a surprise, investors took the opportunity to buy into the five-year sector, Noble said.

"I'd say that the very well-telegraphed and well-expected announcement by the Fed to purchase in the five-year sector helped," he said. "It had been lagging other sectors over the past two to three weeks."

Minutes from the Fed's January meeting had raised some concern on Wednesday about the possibility that the Fed would sell some of the agency notes that it has bought and will continue to buy until the end of March, Noble said. But Thursday's announcement of the next purchase operation was a reminder that the Fed has more to buy.

"The reality is they're not done buying yet," he said. "Maybe in the long term, but in the here and now, they're still buying, and now we've had just the third benchmark issue of the year. Benchmark supply is still very limited and the Fed is still buying."

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