Agency curve steepens on FOMC statement; long-end spreads ease as Fed ends debt purchases

By Kenneth Lim

Boston, March 16 - Long-end agency spreads widened on Tuesday as the Federal Reserve confirmed that it will stop its buying program by the end of the month.

On the primary front, Federal Home Loan Banks is expected to announce an offering of two-year Global Notes on Wednesday.

The agency yield curve continued to steepen on Tuesday as longer-dated paper eased out on the Fed's decision not to extend its buying program beyond March 31.

"We have seen lately...a steepening of the agency curve," said Michael Skinner, an agency trader at Wall Street Access. "Ten-year spreads are about 2 basis points wider, the front end's about a touch tighter."

The underperformance at the long end of the curve was in line with a similar steepening in the Treasury curve, Skinner added.

"We're following the Treasury curve, so to speak," he said.

Callable issuance was below average with the uncertainty surrounding the Fed's Open Market Committee meeting on Tuesday keeping investors at bay.

"Medium-term note callable issuance was light ahead of the FOMC announcement," Skinner said. "You don't see a lot of issuance because of that usually."

FHLB could announce an offering in the two-year sector on Wednesday, Skinner said.

"Home Loans is announcing tomorrow," he said. "Market consensus is for another two-year. It probably makes sense. There's a lot of supply that we've seen at the front end recently."

A two-year deal would "fit the curve," he added.

Light volumes

Trading volumes were skimpy on Tuesday as investors waited for the Fed to make a statement at the conclusion of its one-day meeting.

"It was a little quiet ahead of the FOMC announcement," Skinner said. "I think people expected what came. Treasuries had a bit of a relief rally...but as we stand it's business as usual."

The FOMC on Tuesday said it would keep fed funds rates at the low of zero to 25 bps for some time.

"The Committee will maintain the target range for the federal funds rate at 0 to ¼ percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period," the FOMC said in a statement.

Skinner said the announcement was as the market expected.

"It was kind of a ho-hum announcement," he said.

Fed buying to end

FOMC also confirmed that the agency debt and mortgage-backed securities buying programs will end on schedule by March 31.

The news was not a surprise for the market, but that only served to maintain the weakness that has been hitting the longer end of the agency market, Skinner said.

"That's probably part of the reason we're seeing the steepening," he said. "If you buy the paper that matures 10 years down the road, you know the government will come in and do something with the GSEs before that, so there's some uncertainty there."

The Fed's buying, which has gone on for over a year, has been absorbing some of that uncertainty, but investors no longer have a big buyer to fall back on, Skinner said.

"With the Fed buying, you always knew you had a backstop, but now you don't have that anymore," he said. "You have to look at it in a different way."

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