Agencies tighten on better swaps, front-end euros; Fannie Mae sells two-, five-year notes

By Kenneth Lim

Boston, June 9 - Agency spreads tightened across the board on Wednesday as the market benefited from strength in swaps and front-end euros.

Fannie Mae surprised the market by offering a new series of five-year Benchmark Notes in addition to a reopening of existing two-years, but the market's overall strength took the additional supply in stride.

Bullet spreads narrowed by 2 basis points in the two-year sector, while five- and seven-year spreads came in by 1 bp. Spreads in the 10-year sector tightened by 2 bps. Three-year spreads moved sharply inwards, by 6 bps, as the sector benefited from the rolling out of maturing debt. Overall trading volumes were decent.

"Optically threes were 6 [bps] tighter, but taking the roll out they were probably 3 [bps] tighter," an agency trader said.

Callable volumes were weak, with most of the action coming from investors who are reinvesting funds from notes that have been called.

"We really need pullbacks in the market to get guys involved in new issue stuff," the trader said. "The only guys getting involved are those that get called away."

The callable market is also suffering from the perception that it is extremely rich at the moment. Many of the callable notes right now are attractive only if they are called in the next three to six months, the trader explained.

"Callables look very rich compared to bullets right now," the trader said.

Finding help

Agency spreads got some help on Wednesday from strength in front-end euro rates as well as tighter swap spreads.

Short-term euro rates have been doing better and seem to show "some stability at that part of the curve," the trader said.

"The euros drive the swaps," the trader said. "I wouldn't say that swaps drive agencies or mortgages, but when swaps are doing well, it doesn't hurt agencies."

Those factors helped agencies to outperform both Treasuries and swaps on Wednesday, the trader said.

"Spreads are definitely better bid today," the trader said.

Fannie Mae surprises

Fannie Mae added more supply than the market was expecting when its calendar opened on Wednesday.

The agency priced a $1 billion reopening of 1.125% two-year Benchmark Notes on Wednesday to yield 0.97%. The notes sold at 100.327 after an auction. There are currently $5 billion of the notes outstanding.

Fannie Mae also plans to price $3 billion of new five-year Benchmark Notes on Thursday, talked at a spread of 39.5 bps over Treasuries.

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

"The reopening was not a surprise," the trader said. "I thought that they might even pass. But the new five-year was a bit of a surprise."

The reopening came about 1.5 bps through the offer screens, and the market had no problems absorbing the new two-years, the trader said.

"We closed the July 12s at 25 bps over Treasuries yesterday," the trader said. "Today they're 23 bps over."

The new five-year deal is also expected to do well, given a concession of about 1 bp to surrounding issues, the trader said. The fact that none of the agencies have sold benchmark-sized bullets in the sector in about eight months also helps.

The sector is relatively cheap at the moment for investors, although that means it costs Fannie Mae more. But the agency may have had to issue five-years just to keep the sector liquid.

"I think it's more of their hand being forced," the trader said. "It's not that the funding is good for them."

Of the other agencies, Freddie Mac is the next one that may have to also issue five-years even if the funding levels are not optimal.

"They can probably wait a couple of months before they do something, but again I think they'll have to do something by August or October," the trader said.

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