Agencies end mixed as lower absolute yields keep buyers wary; FHLB reopens three-year notes

By Kenneth Lim

Boston, Sept. 14 - Agency spreads closed mixed on Tuesday as buyers took a step back amid another round of rates richening, while Federal Home Loan Banks came with a small reopening of three-year Global Notes.

Two-year bullet spreads closed about 1 basis point narrower against Treasuries on Tuesday, while three-years widened slightly. Further out on the curve, spreads stayed flat.

"On the day, the front end has performed pretty well," an agency trader said. "Overall, the underlying Treasury curve has been flattening, so there has been some better buying at higher yields, but that has abated a little bit with the rally in Treasuries."

Callable spreads and yields came in slightly, although the market's volatility kept deal sizes small.

"We priced a small step-up deal this morning, but as we were trying to get that done, volatility was going off, swaps spreads were coming down. ... A lot of paper written, but for the most part it kind of reverted back to the retail type step-up structures, not the billion-dollar size deals like you saw last week."

FHLB sells three-years

Federal Home Loan Banks' three-year 1.875% Global Notes ended flat on Tuesday after a $1 billion reopening that priced to yield 0.918%.

The notes were sold at 102.608 through an auction.

The auction had bids for 2.9 times the amount of notes sold.

FHLB may have been reluctant to do a bigger deal because the three-year sector was expensive for issuers.

"I think that the market was pretty much pricing Home Loans out of the market in terms of a new issue," the trader said.

The trader said the market was not very surprised, noting that the agency did not have huge funding requirements.

"They're pretty Libor sensitive," the trader said. "Given where stuff are coming, their secondary is trading a little rich to surrounding issues. By reopening the existing June '13s, taking an issue that was trading rich to surrounding issues and utilizing that, I think they got what they wanted."

Corporate effects

The agency market faced pressure from the slew of corporate deals over the past week.

"Some of the hedging of those bonds led to the selling late last week in rates, and the lifting of the hedges caused the market to lift yesterday," the trader said. "Because yields have gone back down, that's led to a slower tone this week."

Issuers and underwriters typically try to lock in rates ahead of new deals, which lead to tighter bids in swaps and weakness in Treasuries.

"They sell Treasuries into the marketplace to lock rates in, and conversely when the deal is priced ... they have to lift that hedge, so if you take the magnitude that we have now, it kind of lends itself to where we were last week," the trader said.

The glut of corporate paper, some of it investment grade, has also drawn some money looking for better yields.

"I would say there's a trend toward that, but on the other hand you talk to some of the corporate participants, and they'll tell you that some of the value in corporates have leaked out a little bit. Having said that, you do see some profit taking from agencies to make room."

Buyers lurking

Buyers are carefully watching the market and could pounce on another backup in rates, the trader said.

"Agencies had generally been ... historically cheap versus swaps, so there's definitely a sense of historical value there. People are positioning themselves for a backup."

The looming end to the quarter and the year could also lead to some buying in the weeks ahead, especially amid renewed speculation of another round of open-market purchasing by the Treasury.

"We've gained momentum with talk of the next round of QE," the trader said. "We're not at quarter end yet, but we're getting into sniffing range of quarter end."

The bond markets' correction the previous week was a much-needed, technicals-driven move, but prices and spreads are still trading in a range, the trader said.

"We're not seeing a lot of reason to trade out of the range that we're at right now," the trader said.

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