Agency spreads weaken with swaps as market awaits Fed meeting, Freddie Mac announcement

By Kenneth Lim

Boston, Jan. 26 - Agency spreads followed swaps wider on Tuesday as investors wavered amid uncertainty on the regulatory and supply fronts.

Monday's tightening proved to be short-lived as bullet spreads shifted out slightly by 1 to 2 basis points on Tuesday, one trader said.

"Spreads to be honest seem a little soft," the trader said. "We've seen some what I would describe as better selling in the screens. It may be following swaps a little wider, but generally speaking we're seeing some selling in the Street. It seems that guys are lightening up."

Looking ahead, Freddie Mac on Thursday will announce whether it will offer new Reference Notes. The trader said he expects the agency to reopen an existing series of five-year notes.

Still digesting

The trader said investors could still be trying to recover from the bingeing that took place earlier in the month.

"I think maybe guys got a little excited at the beginning of the year loading up on spreads," the trader said. "That's particularly true with some of the TAPs. Some of the guys aggressively underwrote a lot of TAPs, and now they don't know what to do with them. There are hundreds of millions floating in the Street."

The slowly disappearing presence of the Federal Reserve, which is buying agency notes from the market every week until the end of March through the Federal Reserve Bank of New York, also weighs on the market. The Fed has bought about $162 billion of the $175 billion that it plans to purchase.

"I think to some extent some of the widening you're seeing is the market discounting these buybacks," the trader said. "The amounts are getting smaller, the percentages are getting smaller. I think, generally speaking, people are factoring them out of the market."

Standing on sidelines

Another trader said volumes were relatively light on Tuesday with a number of investors staying on the sidelines.

"Trading was pretty evenly distributed; nothing really stands out," the second trader said.

The market's hesitation is probably rooted in the high level of volatility in the markets at the moment, the trader added. One of the key uncertainties is the Federal Open Market Committee meeting taking place Tuesday and Wednesday, from which the market hopes to distill some guidance on the central bank's interest rate policy and its open-market operations.

"I think everyone's keeping an eye on it, definitely," the trader said. "I'm not going to speculate on what they're going to say, but I know it's on the top of everybody's minds. I think we're kind of approaching a new valuation range, if you will, after all the tightening at the start of the year, and people are trying to figure out if this is where we're going to be staying."

The Freddie Mac Reference Notes announcement on Thursday is also a question mark for the market.

"The supply picture's another uncertainty," the trader said. "You're probably going to see a little bit of softening in the sector that they're coming in."

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