Agency spreads narrow as rates backup draws buyers; TVA sells $1.5 billion 30-year bonds

By Kenneth Lim

Boston, Sept. 16 - Agency spreads contracted on Wednesday as a backup in interest rates brought out the bargain hunters despite concerns about the scaling back of a federal borrowing program.

Meanwhile, Tennessee Valley Authority priced $1.5 billion of 30-year Power notes on Wednesday to yield 5.325%.

Bullet spreads were about 2 to 3 basis points tighter across the yield curve with strong bidding interest, an agency trader said.

"Spreads were tighter on the course of the day," the trader said. "It was just good buying."

Drawing out the buyers was a backup in interest rates as Treasury prices and stocks rallied on positive industrial production data.

"We had the backup in rates," the trader said. "The [Treasury] twos are probably about 8 bps cheaper, fives are 7 bps cheaper, so [there was] just good buying across the curve."

Callables remained active, although spreads were mostly unchanged on that front.

There was "lots of business in callables, lots of good callable buying, lots of good callable inquiries," the trader said. "I don't know if they've moved much in terms of spreads, though."

Overall agency volumes were heavier compared to the first two days of the week.

"Definitely a lot of pickup," the trader said.

TVA sells 30-year bonds

Tennessee Valley Authority priced $1.5 billion of 30-year Power bonds at a spread of 105 bps over Treasuries, market sources said.

Bookrunners were Bank of America Merrill Lynch and Barclays Capital Inc.

The notes bear a coupon of 5.25% and were sold at 98.882, representing a yield of 5.325%.

The federally owned electricity and economic development provider is based in Knoxville, Tenn.

Fed buybacks in focus

The Treasury on Wednesday also said it will shrink its Supplementary Financing Program, raising concerns that the Federal Reserve's purchasing programs could also be scaled back.

"There's a little bit of a sense that the Fed needs to prepare the market somewhat for when the buybacks end," the trader said. "So this floated the thought that at some point it is going to scale back. That was nothing definite, just a shot across the bow...Spreads tightened despite of this."

The Treasury will reduce the program, under which the Treasury issues short-term bills for the Fed, to $15 billion from the current $199 billion by letting maturing paper run out.

George Goncalves, chief fixed income rates strategist at Cantor Fitzgerald, wrote in a couple of notes that the move could force some low-risk money funds to shift their money into other assets.

"Those that need their money liquid will probably go into CDs at the banks, which will expand the deposit base again, further benefiting [U.S. Treasuries] out to five years and agencies too," he wrote.

But Goncalves also saw the program's reduction as a possible sign that the Fed may not use up its entire mandate on its agency and mortgage-backed securities purchases. The Fed still has about $75 billion left of a $200 billion mandate to buy in agencies.

"This could be the first sign of the exit strategies that are in store over the next few quarters/years," Goncalves wrote. "That is what I read between the lines when I see this, there is a risk that the Fed believes it has done its job on the asset purchase side and that [quantitative easing] slowdown is next on the docket - stay tuned."

A key sign to watch would be the size of the Fed's weekly purchases in the weeks ahead, he wrote.

If the purchases begin to shrink, "it would validate the theory voiced earlier that with less SFP financing (and with no excess reserve replacement) the Fed is winding down some of these programs sooner than we think," Goncalves said.

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