Agencies narrow as Fed plans to buy Treasuries; FHLB could issue front-end Global Notes

By Kenneth Lim

Boston, Aug. 10 - Agency spreads tightened on Tuesday after the Federal Reserve said it would buy Treasuries to help support the economy.

Bullet spreads closed about 0.5 to 1.5 bps narrower across the yield curve on Tuesday.

"With the Fed doing their thing, we've seen quite a run here especially on the shorter end," said Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial. "We're as tight as we've been in the last month on spreads. There's lots of money chasing very few bonds."

Callable activity was also brisk on expectations that interest rates would remain low for some time.

"Anything that's been written in the last six months is getting called once it can be called," Riley said. "Everything in callables and the step-up market is very active...We're going to be in a low interest-rate environment for at least a year, in my opinion."

Fed to buy Treasuries

The Federal Open Market Committee on Tuesday said it will reinvest maturing agency and agency mortgage-backed debt on its portfolio into two- to 10-year Treasuries to address slower economic growth.

"I think it's going to help the whole market as yields on the 10-year-and-in paper tighten up," Riley said. "People are going to move out to the longer end to pick up more yield. I'm a believer that a 4% long bond is going to look like a bargain in a few months."

Another agency trader said the news was neutral to slightly positive for agency spreads because the target of the new round of quantitative easing was Treasuries.

"The market kind of expected this one, but we still had quite a reaction after it was announced," the trader said. "The direct impact on agencies isn't that great because they're rolling their agency debt into Treasury debt, so it's kind of neutral for agencies but definitely positive for Treasuries."

But absolute yields fell and were expected to stay low because of the buying.

"You could see some investors move out a little on the risk curve because of the low Treasury yields," the trader said. "But at the same time, yields are so low and spreads are so tight that the value in agency bullets is limited as well."

Callables would get a boost from the new round of buying, however, because their higher callable yields are more attractive. More notes will also get called, providing reinvestment interest.

"Callables are going to remain very busy," the trader said.

FHLB in focus

The market now looks to Federal Home Loan Banks for some supply this week. The agency could announce an offering of Global Notes in the three-year sector on Wednesday, the trader said.

"I think they could do a three-year," the trader said. "They haven't done a new issue three-year since April. It's a good time to be issuing paper."

Riley said the agencies may not necessarily issue more bullet debt just because pricing is favorable.

"They have room to issue more debt, but I don't think they're in a position to issue more...they'll issue when they need the cash, and I think they don't need a lot of cash right now."

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