Agency spreads tighten as investors shift out on curve; new Freddie Macs narrow slightly

By Kenneth Lim

Boston, Dec. 1 - Agency spreads continued to contract on Tuesday as the recent buying that began at the front end of the curve began to shift further out.

Freddie Mac's new $4 billion of Reference Notes arrived slightly tighter than initial price talk and managed to narrow a tad more on a quiet debut.

Fannie Mae is on the supply horizon with an announcement on Benchmark Notes expected on Wednesday. Market observers said a deal in the three- to five-year sectors could be in the works.

Trading activity was brisk, trader said.

"It was a fairly active day," said Mark Noble, head of agency at MF Global. "Not a blockbuster volume day, but the new issue of Freddie Mac brought a bit of activity to the marketplace."

Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial, said, "We're in a lot of trades going on today."

Moving outwards

Investors appeared to be shifting beyond shorter-term agencies and into the belly of the curve and beyond as spreads continue to narrow on Tuesday.

"It felt like there was definitely good buying in the longer end of the marketplace," said Mark Noble, head of agency at MF Global. "Five-years, 10-years performed extremely well."

Noble noted that the current spread tightening in agencies began at the front end of the curve.

"There was good demand out there," he said. "Guys were looking for a place to put their money to work, buying the steep part of the curve between two-years and three-years...I think guys reached out on the curve a little bit, and I think today they went out a little bit further."

Riley added that a lot of the pension and insurance fund managers continue to demand agency notes far out on the curve, but the agencies have not been issuing beyond five years.

"I think that appetite remains out there and will continue to remain," he said.

Some accounts are sating their hunger in the municipal markets with Build America Bonds, but those are not perfect alternatives, Riley said.

"The truth of the matter is it's the only game in town," he said.

Freddie Mac narrows on debut

Freddie Mac's new 1.375% Reference Notes due January 2013 narrowed slightly to a spread of 30.5 basis points over Treasuries on their secondary market debut on Tuesday.

The notes priced at a spread of 31 bps over Treasuries. They were sold at 99.903 to yield 1.407%. Price talk was initially at a spread of 31.5 bps over Treasuries but was tightened to 31 bps over Treasuries late Monday.

Barclays Capital, Inc., Banc of America Securities LLC and JPMorgan were the lead managers.

"It kind of came and went without much fanfare," Noble said. "It traded the bulk of the day at 30.5 bps. It outperformed swaps, which after pricing widened about 1.5 bps, but the bulk of the day it was at 30.5 bps."

Riley also saw "lethargic" trading in the new notes, especially in the afternoon, explaining that most of the investors who bought them appeared to be holding on to them.

Pricing on the deal was reasonable, Riley said.

"The pricing is fair for now, but everything's relative of course," he said. "A week ago 31 bps would have been way too rich, but now it's fair. Personally I would love to see higher interest rates across the board, and we would have to become tighter...but we're probably looking at as cheap as this stuff is going to get for the coming week."

Fannie Mae in sights

The market now looks toward Fannie Mae for the next possible shot of supply. The agency has an announcement on Benchmark Notes issuance scheduled for Wednesday.

Noble expects an offering in the three- to five-year area because "Libor valuations appear attractive" in those sectors.

If Fannie Mae decides to reopen a current series, "their existing 2.625% of November 2014 have the highest percentage of being reopened," he added.

Riley also sees a three-year offering as the most likely, if Fannie Mae does not pass on an offering.

"That's the cheapest part of the curve, that one- to five-year sector," he said.

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