Agency spreads ease as Fed buys less at front end; Fannie Mae could pass on next Benchmark

By Kenneth Lim

Boston, Dec. 11 - Agency spreads eased slightly on Friday on slightly thinner volumes as the Federal Reserve Bank of New York carried out a light purchase operation at the front end of the yield curve.

"Spreads are a touch weaker today, but we saw pretty good tightening over the week," said Thomas L. di Galoma, head of U.S. fixed income rates trading at Guggenheim Partners.

Trading activity was muted with only one full week of trading left for the year.

"The volume is still very, very light," di Galoma said. "I think there's been some talk that the Fed might have...tested their reverse repo system [to reduce their portfolios], so that loosened things up a bit, but the impact was laughable."

On the week, spreads tightened by about 5 to 12 basis points in the first four days of the week, with the 10-year spreads narrowing the most, di Galoma said.

But another agency trader said the market did show signs of healthy demand.

"The market continues to chug along," the trader said. "Spreads seem like they're pretty well bid...Those valuations versus swaps are very, very tight. The agency-Libor curve is flattening. It hasn't been helped by a lot of issuance on the front end and not a lot on the back end."

Fed buys at short end

The Fed on Friday bought $1.57 billion of agency notes due December 2010 to November 2011, about 30% of the $5.236 billion of notes tendered.

The acceptance rate of the operation is the smallest since the Fed began the purchasing program, which will be completed at the end of the first quarter of 2010. At the start of November, the Fed was accepting about 42.5% of the notes offered. The Fed has said it will taper its operations as the end of the program approaches.

"The percentages have just been declining," di Galoma said. "It's basically very boring. They just seem to be buying less and less."

The other trader agreed that the declining percentage was not a concern, noting that the Fed is still on track to buy up to $175 billion in total.

"It looks to me... a little on the light side, but I wouldn't read too much into it," the trader said. "I think at the current basis they're slightly under in terms of getting to $175 billion by March 31, but the next one could be a little more. I don't think it's that far off the mark."

Fannie Mae next in line

The market looks ahead to Fannie Mae's scheduled announcement on Dec. 16 on Benchmark Notes issuance. That would be the last announcement for the year on the calendar for the government-sponsored enterprises.

Di Galoma said the agency could reopen a five-year series or sell new three-year notes, similar to what the market had been expecting from Federal Home Loan Banks earlier in the week. FHLB brought a $3 billion offering of new three-year Global Notes on Dec. 8.

But the other trader thought that Fannie Mae would pass on the issuance.

"I would be surprised if they did something," the trader said. "It's not that the market's slowed down that much. But [Fannie Mae] just did a two-year that was $3 billion; Home Loans was a $3 billion, so they just barely crossed the finish line.

"At this point in time, markets are just a little on the slow side, and accounts appear to be not that enthusiastic about the new issue market. And also their funding needs are still generally light."

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