Agencies widen at long end as Fannie Mae supply looms; market shrugs off bin Laden death

By Kenneth Lim

Boston, May 2 - Agency spreads widened slightly in the longer parts of the yield curve on Monday as investors took profit on some of the previous week's tightening.

Bullet spreads closed the day a touch wider in the five- to 10-year sectors, while staying unchanged in other parts of the yield curve, an agency trader said.

"There was a little bit of pressure on the sectors that came in the most on Friday," the trader said.

The longer sectors found a bit of support from investors extending out into later maturities.

"I've seen some guys doing extension trades," the trader said. "Threes, fives and sevens into 10s, 11s and 12s. That longer part of the curve has been getting hit, but I did see people extending into it."

The callable market also saw good demand with the Treasury market grinding higher.

"There was a lot of buying in one-time paper, and some pretty good demand for callable stuff," the trader said.

News overnight that Al-Qaeda leader Osama bin Laden had been killed by U.S. forces had a muted impact on the market beyond an initial rise in yields.

"Then there seemed to be a consensus that it helped all U.S.-dollar denominated assets a little more, so yields went back down," the trader said.

Fannie Mae ahead

The market was undecided about what Fannie Mae might do on Tuesday when it is scheduled to make an issuance announcement on Benchmark Notes, the trader said.

The agency has another calendar slot on May 11, so it could announce three-year notes on Tuesday and skip the next opening or skip Tuesday and issue a week later.

"The Street is split on this," the trader said. "But if they do anything they're going to do a three-year...because it's the richest part of the curve and twos are a little more expensive on an asset-swap basis."

The trader was leaning toward an issuance on Tuesday because Fannie Mae may want to avoid issuing too close to Freddie Mac, which has a slot on May 19.

"I'm going to come with they'll come with a three-year tomorrow," the trader said.

Tight supply

Agency investors are hungry for new supply as the housing agencies find themselves with less need for funding as the housing market continues to struggle, the trader said.

Bullets are also the most expensive form of funding for the agencies at the moment, the trader added, with step-up callables the most attractive option followed by straight callable notes.

"The last thing they really want to issue is bullets," the trader said. "And a lot of the bullets issued are loaded in the front part of the curve, and we're going to see as much if not more passing as we've seen this year."

The trader said the lack of supply has affected the liquidity of the market.

"I know my ability to get in and out of bonds has been affected significantly," the trader said.

News that the Treasury Market Practices Group, an advisory body created by the Federal Reserve Bank of New York, is considering implementing fails charges on agency and agency mortgage-backed securities is also feeding concerns that liquidity could dry up even more if investors start to hoard securities.

"That's just going to make it harder to be short agency benchmarks, which will make it harder to run large agency positions," the trader said.

But demand for agencies remains strong, especially in longer parts of the yield curve.

"I do own agencies on the curve, some fives, sevens and 10s, but in the short end it's horrible, and there's nothing there for me," the trader said.

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