Agency spreads flat on lower Treasuries; Fannie Mae tightens talk on new three-year notes

By Kenneth Lim

Boston, Jan. 13 - Agency spreads ended unchanged on Wednesday, although prices followed Treasuries lower despite a strong auction.

Fannie Mae announced an offering of new three-year Benchmark Notes for Thursday, and price talk tightened slightly over the day with the market expected to gobble up the supply.

Bullet spreads were unchanged across the yield curve on Wednesday, said Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial.

"Spreads were unchanged on the day," he said. "All the action was around the 10-year [Treasury] auction today. We gave up significant ground after the auction."

The U.S. Treasury sold $21 billion of 10-year notes with an above-average bid-to-cover ratio of 3 on Wednesday. But with the stock market rallying and another $13 billion in 30-year Treasury bonds about to hit the market on Thursday, Treasury prices fell over the day. Agencies were dragged along.

"Agencies are an extension of Treasuries at this point," Riley said.

Fannie Mae plans three-years

Price talk was tightened on Fannie Mae's planned three-year Benchmark Notes, which will price Thursday.

Initial price talk was at a spread of 31 basis points over Treasuries, but by the end of Wednesday talk had been narrowed to about 29.5 bps to 30 bps over Treasuries, Riley said.

"That [31 bps] was yesterday," he said. "Today it was at 29.5 bps, but it will probably be closer to 30 bps."

The size of the deal has not been set, but it is expected to be at least $3 billion.

Banc of America Securities, Goldman Sachs & Co. and J.P. Morgan & Co. are the lead managers.

One agency trader said the deal "seems to be going really well [because] it's cheaper than anything else in the sector."

Riley also expects the Fannie Mae offering to receive a good reception from the market.

"It'll go well," he said. "They all go well. We haven't seen one that hasn't gone well."

Even with Federal Farm Credit Banks selling $1.4 billion of new three-year Designated bonds on Monday, there is no concern about oversupply in the market, Riley added.

"Just look at bills," he said. "When anything inside of the Treasury curve, inside of three months can sell billions of billions, there's not going to be a problem."

Callables shift outwards

Callable issuance has not been as active as previous weeks given the current richness of the market, Riley said.

"Callable action hasn't been extremely heavy," he said. "Nobody wants to write a two-year in any significant sense because it's so tight to Treasuries that you're not really getting paid for the option. Most of the deals are 2012 and out."

As an example, he mentioned that Mesirow just sold about $100 million of a one-year step-up that starts at 0.20% and steps up to 0.80% in the final period.

"Are you really getting paid for the call option at 0.20% [for three months]?" he asked.

But there remains a lot of money parked in short-term agency paper, and finding sellers has been difficult despite the richness of the market, Riley said.

"Everybody's just complaining that nobody wants to sell anything even at these levels because they can't replace it with anything," he said. "I think the message that the market is telling you is everybody's worried about a snapback. If we get some good economic data at some point, we're going to fall back. Just not this week."

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