Agency spreads narrow as Fed buys five-years; richer market could spur new issuance: trader

By Kenneth Lim

Boston, Feb. 19 - Agency spreads continued to tighten on Friday as the Federal Reserve Bank of New York bought paper at the belly of the yield curve.

Bullet spreads were about 1 basis point narrower versus Treasuries at the front end of the yield curve, an agency trader said. Five-year spreads eased out slightly by 1 bp following a strong run-up on Thursday.

"In the front end we're 1 bp tighter, but versus swaps we're outperforming strongly," the trader said.

Callable issuance was active as investors continue to seek the potential for higher yields. A large amount of callable debt maturing is also making room for the additional issuance, the trader added.

"Callables are still very active, particularly in the front end where they get recycled," the trader said. "We still see very strong interest in that part of the curve, three years and in."

Richening could bump issuance

The agency market has been tightening for most of the past two weeks, and at current levels valuations are rather rich, the trader said.

"Spreads continue to be pretty firm on the back of what we think has been some good customer buying," the trader said.

The low relative yields could lure issuers back to the languishing primary market, the trader said.

"I think valuations have gotten pretty rich," the trader said. "And I think that's going to potentially bring about some issuance from the agencies. I would expect to see some bump-up in issuance."

Looking ahead, Fannie Mae is expected to announce on Feb. 25 whether it will issue Benchmark Notes. The agency will probably issue new two- or five-year notes, the trader said.

Fed buys five-years

The Fed bought $946 million of five- to six-year agency notes on Friday as part of its weekly outright coupon purchase program.

The central bank was offered $3.154 billion of notes, implying an acceptance rate of 30%.

Most of the notes that were bought by the bank came from a single issue - $711 million of Freddie Mac's on-the-run 2.875% notes due February 2015.

"It was kind of disappointing just from the standpoint that...they did most of the buyback in the on-the-run Freddie Macs," the trader said. "There was already a lot of liquidity in that issue."

The trader said some of the off-the-run issues that were eligible for purchase were cheaper than the Freddie Mac note that dominated Friday's operation, and reckoned that the Fed may have prioritized buying from a larger issue.

"I guess their criteria was getting a good size," the trader said.

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