Agency spreads narrow as investors seek cheapened bullets; FHLB could offer three-year Globals

By Kenneth Lim

Boston, Feb. 16 - Agency spreads tightened slightly on Tuesday as investors took advantage of recent cheapening.

The market also expects Federal Home Loan Banks to announce on Wednesday an issuance at the front end of the yield curve.

Bullet spreads narrowed by about 1 basis point across the curve on Tuesday, continuing the slow strengthening from the previous week.

"It was kind of a mixed day in the sense that there was a lot of demand for bullet paper but not for callable paper, which is the reverse of what you usually see," said Michael Skinner, an agency trader at Wall Street Access.

Skinner sees the slowdown in callable action on Tuesday as only a temporary break.

"Year-to-date callable demand has been pretty strong, particularly in short-term maturities," he said. "Callable demand has pulled off the last couple of days, but it should remain fairly robust."

Bargain hunting

Some of the interest in agency bullets on Tuesday came from investors who found that "benchmarks have gotten a little too cheap" over the past few weeks, Skinner said.

"We've been range-bound, and typically in range-bound trading times, investors like the incremental yields that agencies provide," he said. "There are some accounts that need to buy agencies, and because it's gotten cheaper they're coming in now."

A lack of supply has also been driving pent-up demand in the market, with Fannie Mae and Freddie Mac forgoing benchmark-sized bullet issuance the previous two weeks, he added.

"At the end of the day, there's only so many opportunities to get your hands on Aaa paper," Skinner said.

But the agency market remains stuck in a range, and escape may eventually come from broader economic developments, he said.

"We're keeping our eyes on all times certainly on geopolitical risks," Skinner said. "Certainly an increase in jobs would take us out of the range. A couple of months of positive employment gains will bring us out of the range, but going the other way, if this is going to be a two-part recession, yields are going to go lower faster."

FHLB could target short end

FHLB could issue about $3 billion of three-year Global Notes during the week, Skinner said.

The home loan agency is scheduled to announce on Wednesday whether it will offer any Globals this week.

The offering will be closely watched by investors and should be the main event for the market in the week, he said. Without any competition, the deal will probably do well.

"I assume it's going to do well," Skinner said. "Certainly the Home Loans announcement will be the highlight of the week. There's no other news that I see on the horizon."

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