Agencies narrow as economic, Europe concerns flatten curve; Fannie Mae deal sees demand

By Kenneth Lim

Boston, Aug. 17 - Agency spreads tightened modestly Wednesday as Fannie Mae found strong demand for a $4 billion offering of five-year Benchmark Notes.

Bullet spreads closed the day about half a basis point tighter to unchanged versus Treasuries, moving in tandem with Treasuries, which rallied at the back end of the yield curve.

"There was two-way flow in the morning, and it kind of stopped in the afternoon," said Craig Ziegler, an agency trader at Gleacher & Co.

The callable market remained strong, as investors continued to reinvest money from notes that have been redeemed because of the recent drop in yields. Issuers are calling back "billions" of paper every day at the moment, Ziegler said.

"Callable issuance remains robust as a tremendous amount of bonds are getting called because of lower yields," he said. "A lot of deals just keep going to market."

Most of the interest in callables has focused on paper with tenors that are three years and shorter, he added.

Although some other traders have noted wariness by issuers about higher yields possibly pricing some investors out and making it hard to sell enough to meet funding needs, appetite for callables remains robust, Ziegler said.

"In the front end they've been buying them up," he said. "Maybe that stops when the money stops, but for now it's kind of a continuous stream."

Yields slip further

Yields continued to decline Wednesday, especially in longer maturities, as concerns about the economy and Europe kept a modest flight to quality going despite an early rally in equities.

"Yields were all over the place today," a government bond trader said. "Rates were pretty much following the lead of the stock markets, which have been very volatile. We were up in yields in the morning, then stocks fell back, yields came back down, and we're going out lower in yields than yesterday."

Concerns that Europe's leadership does not have an adequate plan in place to address the mounting debt crisis of peripheral economies continue to plague investors.

The domestic economy is also believed to be extremely weak, and expectations of an extended period of weak growth are helping to boost demand for safe-haven assets. But front-end yields are already extremely low and do not have much room to move, which is why the yield curve has been flattening the past few days.

"People are being forced out on the curve," the trader said.

Fannie Mae sells five-years

Fannie Mae sold $4 billion of new five-year Benchmark Notes on Wednesday at a spread of 35.5 bps over Treasuries.

The notes were sold at 99.818 to yield 1.287%. Price talk was at a spread of 35 bps over Treasuries.

The new paper closed the day with a bid of about 35.5 bps over Treasuries.

Barclays Capital Inc., J.P. Morgan Securities LLC and UBS Securities LLC were the lead managers.

"The new Fannie Mae went well," Ziegler said. "At about 3 bps concession to surrounding issues, it's bound to do very well."

The deal saw strong participation from fund managers, who took 49.3% of the notes offered, while central banks bought 27.3% of the deal. Domestic investors formed the majority of the buyers, accounting for 70.1% of the offering.

When Fannie Mae announced the deal, most of the market was expecting a three-year offering, but a five-year offering still allowed the issuer to capture a favorable rate, Ziegler said.

"From a funding point of view, anywhere in twos, threes or fives made sense," he said.

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