Agencies narrow amid low yields, possible Fed buying; Freddie Mac offers two-year notes

By Kenneth Lim

Boston, Oct. 19 - Agency spreads continued to tighten on a quiet Tuesday amid strong demand for high-grade issues, while Freddie Mac announced an offering of two-year notes.

Bullets closed a touch tighter on Tuesday, with two-year spreads about a quarter-basis point narrower versus Treasuries despite Freddie Mac's announcement.

"They're hanging in there," an agency trader said. "Two-year spreads actually came in a little bit today, maybe 0.25 bp tighter. For the most part, all are slightly tighter across the board."

The market would not get any excitement from the callables, with issuance on that front slowing down for the first two days of the week.

"It's been fairly slow," the trader said. "With implied volatility as low as they are, there hasn't been a ton of demand. Most money managers are feeling like they're not being rewarded for shorting the optionality."

Freddie Mac sees strong demand

Freddie Mac's planned offering of new two-year Reference Notes saw strong orders heading into pricing on Wednesday.

Price talk on the deal was set at a spread of 14 bps over Treasuries. The size of the deal has not been set, but it is expected to be at least $3 billion.

UBS Investment Bank, Goldman Sachs & Co. and Deutsche Bank Securities Inc. are the lead managers.

"The deal is going very, very well," the trader said. "It's already issue bid. Anything in the front end right now is doing very well."

The order book was slightly north of $5 billion just after the close of the market, the trader said.

"It's not quite oversubscribed yet, but by the end of the night it will be," the trader said.

At 14 bps over Treasuries, the deal was flat to only about 0.5 bp cheaper than surrounding issues, the trader said. The deal managers can afford to be aggressive in pricing because demand for new front-end paper is extremely strong at the moment.

"There's enough new demand to bring it at market if not slightly through the market," the trader said.

Volumes linger in doldrums

Trading volumes have been lackluster the past several sessions, extending into the previous week. The trader was puzzled by the slow activity but said a couple of reasons could be behind the thin trading.

"It could be people are still focusing on quarter-end," the trader said. "It could also be the fact that rates overall have gotten so low and spreads so tight that people are hoarding cash or buying front-end issues like the Freddie Mac two-year."

The hope is that economic data later in the week will drive some volatility in the agency market and spur trading.

"We need that right now," the trader said.

Amid the low volumes, agency spreads have been grinding tighter. Investors are still keen on agency paper despite the tight spreads because yields have also been falling, and the spreads represent a significant pick-up on a percentage basis compared to Treasury coupons.

"People are doing anything and everything that they can for extra yield," the trader said.

The possibility of further quantitative easing by the Federal Reserve is also spurring spread buying.

"People are still making bets on the thought that they will buy more spread products to put on their balance sheets," the trader said.

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