Agency spreads tighten on Freddie Mac offering, Fed plan to buy seven- to 22-year paper

By Kenneth Lim

Boston, Jan. 6 - Agency spreads tightened on Wednesday as the first benchmark-sized offering of the year got off to a strong start and the Federal Reserve Bank of New York announced a purchase operation.

Bullet spreads narrowed across the yield curve on Wednesday, said Craig Ziegler, an agency trader at Broadpoint.

"It was tighter," he said. "The long end did a lot better. There's generally good tone today, especially at the long end after the Fed announced the buyback."

The Fed on Wednesday said it will buy agency notes from the open market on Thursday. The notes targeted by the Fed mature from July 2016 to July 2032.

Investors were not expecting an operation in the seven- to 20-year sectors, Ziegler said.

"The sector kind of surprised a lot of people, especially with Freddie Mac coming at the front end," he said.

Freddie Mac gets good response

Freddie Mac's new 2.875% Reference Notes due February 2015 tightened slightly to a spread of about 27 bps on Wednesday shortly after pricing.

The $4 billion of notes arrived at a spread of 27.5 bps, in line with price talk, and traded as tight as 26.5 bps. The notes were sold at 99.974 to yield 2.88%.

Barclays Capital Inc., Deutsche Bank Securities Inc. and Citigroup Global Markets Inc. were the lead managers.

"It came kind of fair to the market," Ziegler said. "There were a lot of orders for it. It was well-received. Freddie Mac hasn't come with a new issue since July."

An agency analyst said the order book reached $3 billion within an hour, "so there's a lot of demand."

The offering's strength was heartening for investors, who had been concerned about the large amount of supply coming into credit markets, especially from the Treasury, supranationals and sovereigns and high-grade corporates.

"A lot of people came into this year saying, look at supras, look at corporates," the analyst said. "There's going to be a lot of debt sloshing around, and everyone's so concerned.

"It's only been three days since the start of the year and to me it feels like a month. But it's interesting. Freddie Mac comes with this and it just gets gobbled up."

The demand picture for the agency market looks healthy based on the Freddie Mac deal, but the economy's outlook will help to determine investor appetite for the rest of the year, the analyst said.

If the economy continues a slow recovery, corporate spreads could tighten to a point where investors would rather just buy agencies, which would not offer as much yield but would enjoy strong government support, the analyst said.

"If the recovery stays on two feet, or even only on one foot, there will be a lot of interest in Aaa," the analyst said. "And at those spreads I could just get Treasuries, but why go into Treasuries? You might as well just go into the next notch over Treasuries, which is agencies."

FOMC minutes reflect support

The market was also encouraged by minutes of the Federal Open Market Committee's December meeting, which reflected a cautious approach by the central bank toward exiting its various market stimulus programs.

In particular, the Fed left open the possibility that its $175 billion agency purchase program, which is due to end on March 31, could still be increased or extended if necessary.

"I don't really think they're targeting debt," the analyst said. "They'll be targeting mortgage-backed securities if anything, but they're leaving the door open and worrying about the effects of withdrawing stimulus, and it definitely helps."

The minutes, however, also reinforce the extraordinary exposure that the U.S. government has to the various credit markets, including agencies, and should assure investors that the government-sponsored enterprises will not be abandoned, the analyst added.

"There's no walking away, because if the government walks away from the GSEs, the people, who own all of those bonds, are going to take a hit," the analyst said.

Missing from the minutes is a clear plan for the Fed's eventual exit from the markets, the analyst noted.

"One of the big questions that people are concerned about is the exit strategy, but nobody really understands right now what the exit strategy really means," the analyst said.

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