Agencies tighten as rates rally forces investors out on curve; Freddie Mac sells two-years

By Kenneth Lim

Boston, Oct. 20 - Agencies narrowed on Wednesday as the Treasury rally pushed real money investors into higher-yielding spread products.

Freddie Mac's new $5 billion of two-year Reference Notes arrived tighter than initial price talk and narrowed further over the day in line with the rest of the sector.

Bullet spreads tightened by about 1 to 2 basis points in the three- to five-year sectors and even more in 10-years and longer.

"It seems like there's real money buying going on out there," an agency trader said of the longer end of the yield curve.

Callables saw good buying on Wednesday as investors took up the excess inventory that had been building over the past few days.

Step-up structures continue to dominate the callable issuance tables.

"I know they make sense, particularly for the insurance and pension fund types who are willing to give up coupons at the start for some defensiveness," the trader said.

Freddie Mac sells two-years

Freddie Mac priced $5 billion of new 0.375% two-year Reference Notes on Wednesday at a spread of 12.5 basis points over Treasuries.

The notes were sold at 99.772 to yield 0.484%.

Price talk was at a spread of 14 bps over Treasuries. The size of the deal was indicated to be at least $3 billion during marketing.

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

The new notes ended the day at a spread of about 11.5 bps over Treasuries. Despite the tightening and the large amount of notes sold, the market was surprisingly quiet regarding the offering after pricing.

"My feeling is it didn't go as strongly as they advertised, just in the post-pricing trading," the trader said. "I'm hearing it may be 11.5 bps going away...but I don't think it's on the strength of the issue, but on the strength of the market."

Long end benefits

The real money interest in agencies was prompted by the recent run-up in Treasury prices, which forced some investors out on the yield and risk curve to try and pick up better returns, the trader added. Agency paper from the 10- to 30-year sectors outperformed on Wednesday.

"It's just a forced issue," the trader said.

The yield curve steepened dramatically over the past week on expectations of an aggressive Federal Reserve position on inflation and the possibility of quantitative easing. Some of that pessimism about longer maturities, however, may have been overdone.

"When they got back to 4% in the bond, that brought in buyers," the trader said. "I'm not talking about agencies in general, just rate markets in general. But if people are buying Treasuries, an extension of that is to buy agencies as well."

Some widening and increases in yields would be welcome in the market.

"I wish we'd get a little bit of a pullback like late yesterday or this morning, because there were some accounts that looked like they were interested in trading," the trader said.

Some investors could take profit as the market hits the lower end of yield ranges.

"For the foreseeable future, until [the Federal Open Market Committee meeting] Nov. 3, every time you see a pullback you're going to see people buying on the dip," the trader said.

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