Agency spreads narrow as bargain hunters return; Fed surprises market two-year purchases

By Kenneth Lim

Boston, Sept. 17 - Agency spreads tightened on Thursday as investors sought yield and the Federal Reserve Bank of New York provided unexpected support at the short end of the curve.

Bullet spreads were about 2 basis points tighter over Treasuries in two-years, flattish in three-years and slightly narrower in five- to 10-years, an agency trader said.

"We pretty much were bid all day," the trader said.

Callable issuance continued at a brisk pace, although spreads were not seen to change much in the structured space.

"Callable spreads are pretty much unchanged across the board," said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson & Co.

A fixed income trader said Tennessee Valley Authority's new 5.25% Power Bonds due 2039 continued to tighten considerably.

"The TVAs went out yesterday about 97/92, they traded today as tight as 89/87, so they're in like 16 basis points since pricing," the fixed income trader said. "They're beginning to look a little on the rich side now, and you'll probably see some profit taking tomorrow, I'd expect them to go back to the low 90s."

Tennessee Valley on Wednesday priced $1.5 billion of the bonds at a spread of 105 bps over Treasuries, market sources said.

Bookrunners were Bank of America Merrill Lynch and Barclays Capital.

The notes were sold at 98.882, representing a yield of 5.325%.

The agency trader said Thursday's market was an improvement from earlier in the week, which had been quieter.

"There's still a lot of money that's sitting and waiting to be spent," the trader said. "We've been competing with the new issue corporates that have come this week and the supranationals, and today there was the $5 billion FDIC-insured deal [from Citigroup Inc.], so a fair amount of stuff out there competing against agencies as people sold agencies to buy other spread products."

That competition helped to push agency prices lower earlier in the week, but with the primary market activity mostly over on Thursday, investors came back to agencies, the trader said.

"Agencies have cheapened up, so they're a viable opportunity to go out and grab some yield," the trader said.

Fed surprises market

The Fed threw the market a curveball on Thursday by targeting the shorter paper in its weekly purchasing program instead of farther out on the yield curve.

The Fed said that it will buy agency paper due 2010 and 2011 on Friday as part of its open-market operations.

The market had been expecting a move in the seven-year sector, and the surprise helped the front end of the yield curve to have a strong session on Thursday, market sources said.

"The shorter end did better simply because of the Fed, which said they were buying ones and twos," the fixed income trader said. "We were actually expecting the long end."

The Street's expectations were partly due to recent neglect by the Fed, the trader said.

"They haven't bought in the long end in a long time," the fixed income trader said. "The Street for some reason was looking for something in the long end, but they haven't done ones or twos in a while also. Maybe the next one they'll do will be in the longer end."

The agency trader said the Fed may have been opportunistic in its latest move.

"With the front end backing up the last two days, I suppose you could say the Fed used that opportunity to come in and purchase that sector, try and drive it down a little bit," the trader said.

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