Agencies tighten on bargain hunting as yields cheapen after FOMC minutes; Freddie Mac eyed

By Kenneth Lim

Boston, May 18 - Agency spreads narrowed a touch on Wednesday as yield levels rose on profit-taking in Treasuries.

Bullet spreads closed about one-half to 1 basis point tighter against Treasuries, an agency trader said.

"It was a pretty good day," the trader said.

The callable market also had a more active session as yields rose for the first time in about a week.

"We saw some buying on the pullback," the trader said.

Investors were particularly interested in structures with May maturities because the banks are beginning to shut down their funding cycles for May and are now issuing June maturities, the trader added.

"May maturities are really hard to come by," the trader said. "Anything you can underwrite with May settlement is going to sell really well. We had one and we were very successful with that deal."

Yields rise on profit-taking

Yield levels increased Wednesday as Treasury investors backed off of year-lows that had been reached the day before.

Part of the sell-off was sparked by the release of the Federal Open Market Committee's minutes from its April meeting. The Fed has said that it believes the recent spike in oil and commodity prices will have only a "transitory" effect on inflation, but the minutes showed that some members of the policymaking body were worried that the impact of higher prices could be more problematic.

"Many participants had become more concerned about the upside risks to the inflation outlook, including the possibilities that oil prices might continue to rise, that there might be greater pass-through of higher commodity costs into broader price measures, and that elevated overall inflation caused by higher energy and other commodity prices could lead to a rise in longer-term inflation expectations," the Fed minutes stated.

But the end of the week-long rally created an opening for buyers to return to the market, and agency investors were quick to buy on the pull-back, the trader said.

"We saw a little bit more flow today as the market pulled back," the trader said.

The enthusiastic buying even as yields fell suggested that yields could go lower still, the trader said.

"As rates pushed down and down, people were selling longer maturities," the trader said. "Now it looks like we could pass 3% in 10s. They kind of used yesterday as kind of a sell into the run."

Freddie Mac ahead

The market was not seen setting up for potential supply from Freddie Mac, which has an issuance announcement scheduled for Thursday.

Just days after Federal Home Loan Banks skipped its calendar slot, the market expects Freddie Mac to do the same.

"So far right now, I'm thinking it could be a pass," the trader said. "If they do something, it'll probably be in the three- to four-year sector."

The trader said two-year funding costs are also attractive for Freddie Mac, but issuing a three-year will not cost much more for the agency.

"They could extend into three years and it wouldn't cost them that much more," the trader said. "Four-years they'd have to pay a little more, but it's not very expensive."

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