Agencies tighten despite false scare by Fannie Mae, Freddie Mac; FHLB eyes $3 billion deal

By Kenneth Lim

Boston, June 16 - Agency spreads continued to narrow on Wednesday as investors gained confidence that the Federal Reserve will hold rates at the current low levels for a significant period.

Federal Home Loan Banks announced a $3 billion offering of two-year Global Notes, which saw price talk tighten in line with the sector during the day.

Bullet spreads closed slightly tighter versus Treasuries across the board on Wednesday, an agency trader said.

"Swaps are a little firmer on the day, but we definitely outperformed," the trader said. There was "just better buying in general."

The move came amid recent news reports that raised the possibility of the Fed restarting its asset-purchasing programs if the economy needed another boost, the trader said. A recent Reuters survey of 90 economists also suggested that the Fed could keep rates steady until 2011.

"It's not on any particular pullback...but some of that has filtered into our market and supported better buying," the trader said. "There's a lot of cash that just keeps coming back in."

Trading volumes, however, remained thin.

"It's been a little below average the last two days here," the trader said. "I expect the pickup will be when the Home Loans deal prices and you get some flows coming out of the market."

Callable spreads have been narrowing as the market settles into a range and "volatility continues to get sucked out of the market," the trader said.

"There's not a lot of buyers of volatility right now," the trader said. "The mortgage issuers don't have as much needs as they have in the past and the refinancing wave has slowed down, so there's no reason to bid volatility up."

Step-up structures are the portion of the market that continues to see much action, with retail investors driving most of that business.

"Every regional dealer has printed them left and right," the trader said.

Fannie, Freddie to delist

The market got a slight scare early Wednesday when Fannie Mae and Freddie Mac halted trading in their shares.

But investors breathed a collective sigh of relief when the agencies eventually announced that they would delist their shares from the New York Stock Exchange and the Chicago Stock Exchange.

"We were kind of on our heels coming out of the gate because of the halt by Fannie Mae and Freddie Mac," the trader said. "When it was just the stock delisting we kind of brushed it aside. It's not a big surprise."

The agencies were notified on Tuesday by NYSE that they did not meet listing standards. The Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, directed both government-sponsored enterprises on Wednesday to delist.

"FHFA's determination to direct each company to delist does not constitute any reflection on either enterprise's current performance or future direction, nor does delisting imply any other findings or determination on the part of FHFA as regulator or conservator," said FHFA acting director Edward J. DeMarco in a statement.

George Goncalves, head of U.S. interest rates strategy at Nomura Securities International, said investors were not "terribly surprised" by the announcement because both agencies' shares had essentially become pieces of government debt.

"They've been, in one shape or another, big recipients of government credit...I think the market was not really taken aback by it," he said.

FHLB to sell two-years

FHLB plans to price $3 billion of new two-year Global Notes on Thursday, talked at a spread of 24 basis points over Treasuries.

Price talk was initially set at 26 bps over Treasuries.

"That's primarily due to the rest of the market tightening," the trader said.

Credit Suisse, Deutsche Bank and UBS Securities are the lead managers of the offering.

Price talk is at a concession of about 1 bp to surrounding paper, compared to about 2 bps at initial price talk, the trader added. But the richer pricing is not necessarily an indication that demand was exceptionally good.

"FHLB likes to price it so it tightens at the break and gets good support," the trader said.

The trader did not expect FHLB to upsize the deal even if demand was strong.

"They're really slaves to funding," the trader said. "They're only going to issue when they get extremely good funding, and they're going to price it so they can get extremely good funding."

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