Agency spreads widen despite Fed buying in seven-years; few surprises seen in budget plan

By Kenneth Lim

Boston, Jan. 29 - Agency spreads ended slightly wider on Friday despite early support at the long end of the yield curve from the Federal Reserve Bank of New York.

Bullet spreads widened by about 0.5 to 1 basis point on Friday across the yield curve, said Michael Skinner, an agency trader at Wall Street Access.

"It was a pretty quiet Friday session," he said. "It's the month-end, but the session wasn't huge. It almost feels like a summer Friday."

The market ended January with two weeks of widening, taking some of the shine off the start of the year, when spreads compressed significantly.

"What we've seen in the last two weeks and the last week in particular is spreads have been leaking a little bit wider," Skinner said. "Part of it is yields are low and part of it is the Fed's buyback program is ending in two months."

Callables slow down

Callable issuance was also weaker than usual on Friday.

"Call issuance was somewhat limited," Skinner said.

Guy LeBas, chief fixed income strategist at Janney Montgomery Scott, said there were "a lot of small new issue deals but nothing major."

Step-up structures, which dominated callable issuance in the second half of 2009, are also seeing a slowdown as retail demand approaches saturation, the analyst said.

"I think we're seeing a little more fixed-rate, four- to six-year maturity issues," LeBas said. "I think we saw a lot of retail buying on the step-up side, and that retail side is going a little tighter with its cash. It's not a seismic shift, but there is limited capital for step-ups."

Fed buys at long end

The Fed bought $989 million of agency notes due October 2016 to June 2018 on Friday as part of its outright coupon purchase program.

The operation had targeted paper maturing up to July 2032, but none of the eligible notes that far out on the curve were purchased. A total of $3.302 billion of notes were offered to the Fed, giving a 30% acceptance rate.

The Fed's buying provided some support to the market in the morning, Skinner said.

"There was a buyback by the Fed in the long end, and that helped in the morning to keep spreads in the seven- to 10-year sectors 0.5 to 1 bp tighter," he said.

But with the Fed buying slated to end by March 31, investors are more concerned about what happens when the government stops buying agency notes rather than the weekly purchases, Skinner said. He did not think that the Fed will extend the program, although they could still maintain some presence in the market.

"I could see them in the market here and there, on the down low," he said, "but nothing official."

Budget ahead

The coming week will begin with the president revealing his budget plan for the year ahead. That plan is expected to include an outline for the future of Fannie Mae and Freddie Mac, which are under federal conservatorship.

But Skinner is not expecting a major shift in the short term.

"I'd personally be surprised if anything dramatic happens," he said. "It'll take them at least two to three years to do anything. Maybe a taskforce will be formed or whatever it may be, and they're going to try to figure out what to do with Fannie Mae and Freddie Mac...one thing's for sure, they can't act the way they're acting and still be a publicly traded stock."

There has also been speculation about whether the government will take the two agencies' debt onto the federal balance sheet, but Skinner also saw that as a distant possibility.

"I doubt it, but if they did they'd have to add another $1.5 trillion to the balance sheet," he said. "I think they're going to take their time."

Skinner sees the market agreeing with him.

"Sub debt maturing in 2013 and in have really ratcheted in in the last month and a half," he said. "That tells me right there they're not going to come up with an answer straightaway. The long end has come out more than the front end, which means the market is thinking that things 10 years and out are going to be affected by whatever they plan, but not three years and in."

LeBas also expected few immediate implications from the budget in terms of Fannie Mae and Freddie Mac, although the impact would probably be greater several years from now.

"In practical terms there's no way to stop supporting these two entities," he said. "They're extremely large and to be blunt abandoning them would create political problems as well as financial ones."

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.