Spreads soften as supply takes toll; wary market looks toward GSE hearings, final Fed purchases

By Kenneth Lim

Boston, March 19 - Agency spreads eased out slightly on Friday as the market tried to digest the recent wave of supply.

Bullet spreads ended 1 to 2 basis points wider, although some buy interest was seen in the 15- to 30-year sectors from rate-based buyers hoping to buy on recent cheapening at the very long end of the yield curve.

Swap spreads, which widened by about 2 bps, put pressure on agency spreads, the trader added. A sluggish market with distractions - many traders were following the collegiate basketball tournament, the trader said - could not pull out a positive day.

"There were a couple of things I think were at play," an agency trader said. "The Treasury market backed up a little bit ... and a lot of bonds were hanging around from the two-year deal that just came out."

Federal Home Loan Banks' new 1.125% Global Notes due May 2012 widened about half of a point to close at a spread of 21.5 bps over Treasuries. The $3 billion offering priced at a spread of 21 bps over Treasuries on Thursday.

The FHLB deal may have tipped the scales after large issues by Fannie Mae and Freddie Mac in the previous two weeks seemed to be easily absorbed by investors.

"For such a small deal, everyone was saying it was a great deal, but ... I think a lot of those guys were sated with the Fannie Mae three-years that came last week," the trader said.

Callables slightly quiet

Callable issuance slowed down a little on Friday as rates backed up, but the market still shows enthusiasm for defensive structures that can work in range-bound environments, the trader said.

"The Fed has come out and said they're going to keep rates low for an extended period, and the next Fed meeting's not for another six weeks, so clients are happy to take a three-month or six-month option here," the trader said. "So callables should definitely outperform in the next three to six months."

Some of the money flowing into callables also comes from the buyouts by Fannie Mae and Freddie Mac of delinquent mortgages because callables are looking cheap compared to mortgage-backed securities at the moment, the trader said.

"Not all of that money that Fannie Mae and Freddie Mac are taking out are going back in," the trader said.

GSE hearing ahead

The House Financial Services Committee will have a hearing on the future of the government-sponsored enterprises on Tuesday, and the market will be watching the event with a little nervousness, the trader said.

"The risk is that somebody, like a [U.S. Representative] Barney Frank scenario, says something stupid and we widen out a few basis points," the trader said, referring to comments made by Frank about the guarantee of the GSEs a few weeks ago that were later clarified by the legislator and the Treasury.

"If someone says something stupid, we might widen out 3 to 5 bps, but we'll probably retrace that the next day," the trader said.

Freddie Mac is also on the calendar with an announcement on Reference Notes on Thursday, while the Federal Reserve Bank of New York will carry out its last agency debt purchase operation.

The Fed has "just a little over $5 billion" left in its $175 billion mandate for the purchase program, the trader noted. The central bank will probably target the long end, but because the operation is the last one, more sectors of the curve could be targeted and the Fed could buy more than usual.

"It's the last one, so why not?" the trader said.

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