Agencies narrow as jobless claims spur flight to quality; Fannie Mae eyes three-year notes

By Kenneth Lim

Boston, Jan. 27 - Agency spreads tightened slightly on Thursday, although the three-year sector softened slightly after Fannie Mae announced an offering of Benchmark Notes.

Bullet spreads in the two-, five- and 10-year sectors narrowed a touch versus Treasuries on Thursday as investors shed risk following poor jobless claims data.

"Agencies kind of reversed some of the widening we saw yesterday, guys were stepping back from the risk-on trade that we saw yesterday," a trader said.

Callable issuance was active, particularly in step-ups, the trader added.

"Step-ups are still going strong," the trader said. "A lot of the people are buying them to lock in higher rates and get a more defensive product than in a straight callable or a bullet."

Weak data spurs bids

A larger-than-expected increase in jobless claims sent investors scurrying toward the safety of higher-grade paper on Thursday. Front-end agency debt is widely seen as one of the safest asset classes because of the U.S. Treasury's backing for Fannie Mae and Freddie Mac until the end of 2012.

"Jobless claims came in higher than most people were expecting, so naturally yields fell lower," the trader said. "Agencies did better than other spread products because we're practically government paper right now. In fact front-end spreads have been trading very tight and in a very tight range since 2009."

The data was also another hurdle of uncertainty that the market passed, freeing up money that had been sitting on the sidelines. Investors had been reluctant to trade for most of the past week because of nervousness surrounding economic data, the president's State of the Union speech on Tuesday, the Federal Open Market Committee meeting statement on Wednesday and the Treasury's auctions of two-, five- and seven-year notes.

"It's been a really eventful week," the trader said. "Unfortunately, it was a little too much action for a lot of people, so we're getting a little bit of a back-end loaded week."

The Treasury auctions also went well, easing concerns about overall market demand.

Fannie Mae plans supply

Fannie Mae plans to price new three-year Benchmark Notes on Friday, talked at a spread of 26.5 basis points over Treasuries, market sources said.

The size of the deal has not been set. Price talk was initially set at a spread of 26 bps, but that was widened later Thursday in line with the market.

Citigroup Global Markets Inc., Deutsche Bank Securities Inc. and Goldman Sachs & Co. are the lead managers.

The three-year sector underperformed slightly on Thursday in anticipation of the supply, a dealer said.

"I think we pretty much saw this coming yesterday," one dealer said. "We saw some selling in the three-year sector yesterday; it kind of solidified the notion that we'd get a three-year deal today."

The deal is expected to do well based on early indications of the order book, the dealer added.

"Pricing is fairly valued," the dealer said. "It looks like it's about half to 1 basis point concession from on-the-run Freddie Macs."

The deal was nevertheless quite aggressively priced, the dealer added.

"It's a little tighter to where recent concessions have come," the dealer said.

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