Agencies tighten across the curve on renewed domestic demand; Fed buys $5.6 billion in short end

By Kenneth Lim

Boston, Aug. 21 - Agency spreads tightened across the yield curve Friday as domestic buyers came out to take advantage of earlier widening and the Federal Reserve bought a larger-than-normal amount of securities.

Spreads shifted in by about 1 to 1.5 basis points across all maturities Friday, said trader Michael Skinner of Wall Street Access. On the week, spreads were mostly wider, with the 10-year sector about 20 bps farther out than a fortnight ago.

"Today there was a Fed purchase operation...out of $11 billion in tenders, the Fed bought $5.5 billion, which was a pretty big amount, so that helped spreads hold on in the front end."

Selling by overseas investors accounted for a significant portion of the spread expansion over the past couple of weeks, but that pressure eased over the past two days, Skinner said.

"They were pushing the market around in typical summer conditions, but yesterday we saw domestic buyers, and definitely the Fed helped," he said.

The week ahead has a scheduled Benchmark Notes issuance announcement by Fannie Mae on Aug. 26, and the agency could target the two- to three-year sector, Skinner said.

Fed buys $5.6 billion

The Federal Reserve Bank of New York on Friday bought $5.605 billion of agency securities as part of its weekly purchasing program.

A total of $11.209 billion of the notes, which matured in 2010 and 2011, were offered.

The amount that was bought was the largest in a week since the open-market operations started, wrote Cantor Fitzgerald head of fixed income rates strategy George Goncalves in a note.

"Is this a sign of more to come?" he wrote. "I think it's too early to jump on that bandwagon as the Fed GSE OMO buying run-rate prior to today's operation has been falling behind schedule (granted the Fed never said it would max out its potential $200 billion allocated to the agency buybacks). I think this is more of a case of cheap securities being offered up at the right time and right price."

Post-Fed concerns

Skinner noted that some of the selling over the past two weeks was also due to uncertainty about how the agency market will react after the Fed's purchasing program expires at the end of the year. Investors are also concerned about how the government plans to handle the eventual structure of Freddie Mac and Fannie Mae, which are currently under conservatorship.

Whatever the government does, investors will be most concerned about how the implicit guarantee will be kept, he said.

"Will there continue to be an implicit guarantee?" he said. "They'll have to somehow address that, and I think somehow the government's going to have to be involved."

Until those issues become clearer, Skinner expects agency spreads to swing around current levels.

"We've got one eye towards the future," he said. "I don't think spreads will tighten significantly from here. Buybacks are going to hold spreads in, but basically there's only four months left in these purchases. We're going to be range bound."

He therefore is not worried about the two weeks of spread widening.

"I've seen good two-way flow at these levels, so I'm not terribly concerned about more widening like we've seen," he said.

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