Agencies narrow at long end on buyback plans that neglect 30-years; Fannie Mae could skip

By Kenneth Lim

Boston, Nov. 3 - Agency spreads tightened at the long end of the yield curve on Wednesday after the Federal Reserve's belly-focused easing announcement sent 30-year Treasuries diving.

"We're seeing real good spread movement further out the curve, from five years and out," an agency trader said. "The long end of the Treasury market got crushed, and that's causing longer end agency spreads to tighten in."

Front-end spreads were unchanged on the day largely because spreads in the short sectors are already at historically tight levels.

"Right now our face is pretty much pressed against the glass at the front end," the trader said.

Callable spreads tightened slightly on the drop in volatility, and they could continue to be on a narrowing bias in the days ahead as investors buy on expectations of the Fed's buying.

"Callable spreads tightened this afternoon," the trader said. "When you buy callable agencies you essentially sell volatility, and when volatility comes off, short-dated volatility falls off."

Fed to buy Treasuries

The Federal Open Market Committee said Wednesday that it will buy an additional $600 billion of Treasuries by the end of June 2011 at a pace of about $75 billion per month. This is in addition to the Fed's already announced plan to reinvest its maturing agency and agency mortgage-backed securities holdings into Treasuries.

In a statement, the New York Fed said the total purchases will be about $110 billion a month. The Fed will allocate about 5% of its purchases to 1.5- to 2.5-year notes; 20% to 2.5- to 4-year notes; 20% to 4- to 5.5-year notes; 23% to 5.5- to 7-year notes; 23% to 7- to 10-year notes; 2% to 10- to 17-year notes; 4% to 17- to 30-year bonds; and 3% to 1.5- to 30-year Treasury Inflation-Protected Securities.

The size of the operation met market expectations and appeared to find a balance between the more conservative and aggressive portions of the market.

"They've gone out and canvassed the primary dealers," the trader said. "I think that they chose to not use all their bullets, and came in relatively in between the proverbial shock and awe and doing nothing."

But the focus on the belly of the curve caught some investors by surprise.

"I think some guys were setting up for the possibility that the 30-year could be included in the buyback," the trader said. "When it was not, they were kind of left holding an empty bag, so to speak, and scrambling to recover. I think that should bring a fair amount of buyers into agencies who were rate buyers."

Fannie Mae, payrolls ahead

The market now turns to the eventful week's next two milestones. On Thursday, Fannie Mae is expected to make a calendar announcement on the issuance of Benchmark Notes.

But given that Fannie Mae issued $9 billion of bullet debt the previous week - $8 billion of new three-year notes and $1 billion of reopened five-years - investors do not expect another big deal this time.

"I'm not expecting much of anything," the trader said. "Maybe a small upsize, possibly passing off given last week. However if we continue to tighten, they could come to market and get a nice level on a new two-year...it just depends on their needs."

Investors will also be watching Friday's employment situation report closely. If payrolls are better than expected, that could push up inflation fears and bring more hurt to 30-year Treasuries.

"Tomorrow, we should see tighter call spreads and probably some money being put to work further out the curve," the trader said. "But there will be some hesitation...Some people are going to wait to see what payrolls show."

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