Agency spreads bounce back after soft week; FOMC meeting, Freddie Mac announcement on horizon

By Kenneth Lim

Boston, Jan. 25 - Agency spreads narrowed slightly on Monday as bargain hunters sought to exploit the previous week's widening.

Caution ahead of the Federal Open Market Committee meeting over the next two days kept volumes muted, while the Street expects Freddie Mac to reopen an existing series of Reference Notes later in the week.

Bullet spreads tightened by about 1 to 2 basis points across the yield curve on Monday, said Mike Goldman, head of agency trading at Guggenheim Partners.

"It was kind of a quiet Monday," Goldman said.

Callable issuance was robust, with about 57 new deals on the new issue monitor, he added. Most of the new callable deals were under $100 million, with only one about $500 million. Step-up offerings were slightly fewer on Monday, although demand for the structure remains strong, Goldman said.

"It continues to be an active day for callables," he said.

Freddie Mac will announce on Thursday whether it will sell Reference Notes. The market currently expects the agency to reopen an existing series of notes, Goldman said.

"The consensus view is probably a reopening," he said. "They still don't have tremendous funding needs. It's most likely going to be a reopening. They just did five-years recently, so I would guess twos and threes."

Oversold market

Investors bought on the cheapness that carried over from the previous week, when spreads moved outwards every day. Friday's agency market was particularly soft after Rep. Barney Frank, who heads the U.S. House Financial Services Committee, said his committee would recommend "abolishing" Fannie Mae and Freddie Mac.

But Goldman said the selling had been overdone and investors came back on Monday to pull up the slack. Spreads widened by about 2 to 3 bps on Friday, he added.

"Agencies were trading very weak to Treasuries, and I think as people thought about it more, they realized that, No. 1, it's not going to happen immediately, and No. 2, even if it happened, it's not necessarily bad for agencies," Goldman said.

If Fannie Mae and Freddie Mac were shut down, the government is unlikely to "abandon" existing debt holders, he said. Outstanding paper could become less liquid, but the likelihood of default should not diminish too much.

The market is also still very hungry for agency paper, he noted.

"A lot of the stuff is just supply and demand dynamics anyway," Goldman said. "And the Fed's still the biggest buyer out there...if there's any kind of widening it just snaps back."

Fed on horizon

Another agency trader said Monday's trading activity was light because some investors were waiting for better direction on Wednesday when the Fed releases statements from its January meeting.

The FOMC will meet Tuesday and Wednesday.

"I think some people are sitting on their money and waiting to see what happens with the Fed meeting," the trader said. "It's the first meeting of the year. It's quite an interesting time for the economy because there's a lot of mixed signals; so, this meeting could signal the Fed's tone for the first half of this year at least."

The market will be looking for guidance on the Fed's interest rates policy as well as any indications about its securities purchase programs. The Fed has been buying agency notes every week and currently has about $162 billion of paper out of the $175 billion allowed under the program.

"They're coming to the end of the buybacks, so they could signal their level of commitment to letting the deadline pass or whether they'll extend it," the trader said.

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