Agencies close mixed on front-end supply, extension buying in belly; Fannie Mae to sell three-years

By Kenneth Lim

Boston, July 7 - Agency spreads ended mixed on Wednesday amid supply at the front end and buyers at the belly of the yield curve.

Bullet spreads closed the day about 1 basis point wider in the three-year sector following issuance announcements by Fannie Mae and KfW Bankengruppe. Five- and seven-year spreads tightened by about 1 bp as money shifted out on the curve to pick up better yields. The two-, 10- and 30-year sectors closed mostly unchanged versus Treasuries.

"Fives and sevens saw tightening as guys extended out," an agency trader said.

Callable issuance continued to see an abundance of step-up deals.

"Things that looked rich two weeks ago look cheap now," the trader said. "Every day it's lower volatility, tighter spreads, lower yields. A lot of paper [is] getting called, and callable demand is still very strong."

Trading volumes on Wednesday were an improvement over the previous few sessions but were still light.

"Today's not bad actually," the trader said. "It's better than average volumes, but it's been pretty bad the past week with the July 4th weekend and the World Cup and all."

Fannie Mae launches deal

Fannie Mae plans to price new three-year Benchmark Notes on Thursday, talked at a spread of 23.5 basis points over Treasuries, market sources said.

The size of the deal has not been set, but initial talk was at a benchmark size of $3 billion.

Citigroup Global Markets Inc., Deutsche Bank Securities Inc. and UBS Securities LLC are the lead managers.

The notes are non-callable.

Price talk represents a concession of about 1.5 bps over current three-year paper, the trader said.

"There hasn't been much of a concession with these recent new issues because demand has been pretty strong," the trader said.

The Fannie Mae offering will meet some competition from KfW, which is selling $5 billion of three-year notes at 18 bps over mid-swaps. Fannie Mae's price talk is about 14 bps below Libor.

"On a relative basis, KfW looks a lot better," the trader said. "Of course, KfW and Fannie Mae are very different...but if you're not already full on the KfW name, obviously it's much more attractive."

But the trader expects that the agency market, which has been starved of new benchmark issuance for almost two weeks, will not have much trouble absorbing all the additional debt.

"I think both issues will go very well," the trader said. "There's enough money waiting to go to work that was just waiting for a back-up...Fannie Mae had other options, and they knew the KfW was coming with a three-year, so they're confident that this will be done."

The one impact that the KfW offering might have on the Fannie Mae deal is that the Fannie Mae offering is less likely to see a sizable upsizing, the trader said.

"Maybe we don't get it growing to $4.5 billion," the trader said.

Tightness to remain

The trader did not expect the new supply to trigger widening in other sectors of the yield curve because demand is stubbornly high.

"The whole market's hoping for it, but that's not going to happen, because we're all going to pour cash in," the trader said. "We see overseas buyers, buyers in London time, domestic accounts are buyers. It's been looking rich to me for two weeks, and they keep buying."

Swap spreads, which are quite closely correlated with agency spreads, could also provide some support this week, the trader said.

"Swaps actually did very well the last couple of days because of new issues, and that's likely to persist this week," the trader said. "But no doubt about it, if swaps widen 10 bps, agencies will widen 4 to 5 bps."

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