Agency debt narrows on Treasury back-up; Fannie Mae's new $6 billion of Benchmarks tighten

By Kenneth Lim

Boston, March 11 - Agency debt tightened on Thursday on a back-up in Treasuries, while investors easily swallowed up a sizable offering by Fannie Mae.

Bullet spreads closed about 1 to 2 basis points tighter versus Treasuries across the yield curve on Thursday, an agency trader said. Two-year notes ended about 2 bps tighter, while three-year paper narrowed by about 1.5 bps. Five-years closed 2 bps tighter, while 10-years moved in by about 1 bp.

"Swaps were a little tighter, so we generally outperformed or [were] flat versus swaps today, which is a little bit of a reversal from the previous week," the trader said. "There's been a steady demand waiting for any back-up in rates, which is what we got today."

With the week's $74 billion of Treasury auctions completed on Thursday, the agency market could continue to strengthen heading into the new week, the trader added.

"With the Treasury sales behind us now, there's nothing really pending hanging over our heads until the next Fed meeting next week," the trader said.

But Friday could see volumes dip in the usual pre-weekend slowdown.

"It's probably going to be quiet tomorrow," the trader said. "We're also starting to hit Spring Break."

Fannie Mae deal sees strength

Fannie Mae's new 1.75% Benchmark Notes due May 2013 narrowed by about 1.5 bps to a closing spread of 29.5 bps bid, 28.5 bps offered after pricing at 31 bps over Treasuries.

The $6 billion deal was sold at 99.839 to yield 1.803%. Price talk was at a spread of 31 bps over Treasuries.

Barclays Capital Inc., Deutsche Bank Securities Inc. and J.P. Morgan & Co. were the lead managers.

"It adds up to a well-placed deal," the trader said.

The size of the offering was larger than some investors had been expecting, but Freddie Mac's $5.5 billion offering of three-year Reference Notes a week ago may have acclimatized the market, the trader said.

Investors were less surprised by the size of the offering, and the Fannie Mae deal was also relatively more attractive relative to Libor, the trader said. While the Freddie Mac deal widened on its debut, Thursday's Fannie Mae offering fared better.

"It seemed to go much better than the Freddie Mac deal last week, where I think the increase in the size on that deal caught a lot of people off guard," the trader said. "People who subscribed to the issue suddenly got more than they really wanted. This deal on the other hand, it was 2 to 3 bps cheap compared to where Freddie Mac priced last week.

"It doesn't surprise me that it saw good demand. Finally, with the rate back-up, you've got a better coupon on the deal."

The trader was more surprised that the Fannie Mae notes did as well as they did in the secondary market.

"I think there were some lessons learned from the Freddie Mac deal last week," the trader said. There were "better market dynamics" and "yields were higher."

But the trader cautioned against reading the strong response to the Fannie Mae offering as a sign that the market will be able to weather the Federal Reserve's pending departure without a problem. The Fed will stop its year-long agency debt buying program by March 31, and investors are concerned about whether the market will be able to pick up the slack. The Fannie Mae deal's performance on Thursday was more about pricing than sheer demand.

"I think they're pricing it at enough of a concession," the trader said. "It's not necessarily new cash...a lot of it is people coming from existing deals or run-offs...ultimately after these deals tighten into the context of the curve then I think the upside is limited."

Callables still strong

Callable issuance continued to be robust on Thursday as volatility remained low, the trader said.

"If you go look at the new issue page, I was just looking up at one point and I saw 18 to 20 deals today that were step-ups," the trader said.

Investors are pouring into step-ups to take advantage of the defensive structures, and underwriters can easily sell new deals even without reverse inquiries, the trader added.

"Volatility has just continued to get crushed, so spreads have tightened in callables versus underlying bullets," the trader said. "I think the prime reason is lack of volatility and pricing levels."

But the trader said the callable market looks rich at the moment.

"At some point the Fed is going to raise rates...then you start to get the market gyrations that will cause the spreads to widen out," the trader said.

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