Agency spreads narrow as Germany ban sparks flight to safety; Fannie Mae prices; FFCB launches

By Kenneth Lim

Boston, May 19 - Agency spreads tightened on Wednesday amid another round of flight-to-quality trading, while the supply market came to life with two new benchmark offerings.

Bullet spreads narrowed by 1 basis point to 1.5 bps across the yield curve, a trader said.

"The market's doing pretty well," the trader said. "With the rally continuing, spreads actually came in."

Callable demand was also strong, although most of the attention was focused on the front end of the curve.

"It's the same scenario [as bullets]," the trader said. "Most people want to stay at the front end, especially if they take a one-year or shorter call, because the curve is so steep. If I buy a three-year, non-callable one year and rates stay the same, it's gone in a year. And if rates rise 35 bps to 40 basis points, I'm still in the money."

Euro worries rise again

Investors on Wednesday were spooked by Germany's decision to ban naked short selling on its government bonds, stoking fears about the possibility of similar action throughout Europe and about the future of the euro.

Rates buyers are still in the market, but they are not looking for bargains out on the yield curve because the current steepness is not coming from an absolute cheapening of longer-dated paper.

"They're scared to get out long," the trader said. "It's not like it was a few months ago, like in December and then again 1.5 months ago, when we had a big spike up in volatility."

That demand for short-term paper has given a boost to front-end agency notes, which in turn helped Fannie Mae to get a strong response for its new three-year 1.5% Benchmark Notes.

The new notes closed at a spread of 27 bps bid, 26 bps offered after pricing at 27 bps over Treasuries.

The notes sold at 99.982 to yield 1.506%. Price talk was initially at a spread of 25 bps, but was widened to 27 bps late Tuesday.

Barclays Capital Inc., Deutsche Bank Securities Inc. and J.P. Morgan & Co. are the lead managers.

"Everything in the front end is doing really, really well, given what's going on globally," the trader said. "People are really concerned about assuming longer-term risk."

FFCB plans deal

Federal Farm Credit Banks also announced new three-year Designated Bonds on Thursday, with price talk at a spread of 30 basis points over Treasuries, market sources said.

The size of the deal has not been set, but it is expected to be in the area of $2 billion.

Banc of America Securities, J.P. Morgan Securities and UBS Securities are the lead managers.

The notes will not be callable.

The deal went "extremely well" during marketing, the trader said.

Strong demand was seen across the board, with the issuer seen as a relatively strong piece of credit to own.

"Pretty much all over," the trader said. "Pretty high concentration domestically, but also a lot of foreign demand. Farm Credit, that is one name that China and many of the Asian banks are not worried about. Their balance sheet is the strongest among the GSEs."

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