Agency spreads widen under shadow of supply; FHLB could offer new two-years, traders say

By Kenneth Lim

Boston, Jan. 19 - Agency spreads widened slightly on Tuesday as investors awaited additional supply from Federal Home Loan Banks.

Bullet spreads softened by about 1 basis point across the yield curve, said Larry Milstein, managing director of governments and agencies trading at R.W. Pressprich & Co.

"Spreads were softer this morning," he said.

Mark Noble, who heads the agency desk at MF Global, said the market appears to be struggling to get beyond the boost that came after the U.S. Treasury on Dec. 24 agreed to back Fannie Mae and Freddie Mac for however much is required to remain in positive net worth.

"It feels like agency spreads five years and out kind of hit a wall," Noble said. "They tightened at the end of 2009 and have kind of slowly moved wider."

Recent new issues have been struggling in such a market, he added. Freddie Mac's 2.875% Reference Notes due February 2015, which were issued on Jan. 6, arrived at a spread of 27.5 bps over Treasuries but on Tuesday closed at around 32 bps over Treasuries. Fannie Mae's 1.75% Benchmark Notes due February 2013, which priced on Jan. 14 at 29.5 bps over Treasuries, closed on Tuesday at a spread of about 30 bps.

"It hasn't really greatly improved at all," Noble said.

Quiet start

Trading volumes were light after the market returned from a three-day weekend.

Pressprich's Milstein described volume as "below average."

Callable issuance was also slower after Friday got a boost in supply from a sizable deal, MF Global's Noble said.

"It was a little quieter than Friday, but in the slight back-up we did see some demand," he said.

Outright investors in particular were eager for five-year callable structures, Noble said.

"The story has been more of accounts looking for additional yields, looking at callables," Noble said.

FHLB did manage to sell $45 million of callables at relatively high premiums, according to data from the agency's web site.

The housing agency priced $20 million of 5.5% 10-year notes, which are callable one time after two years. The notes, which mature in February 2020, priced at 106.56.

Country Club Bank and BMO Capital Markets GKST Inc. are the managers.

FHLB also priced $25 million of 5% eight-year notes, which are callable one time after three years. The notes, which mature January 2018, were priced at 106.73.

SunTrust is the manager.

FHLB could offer at front end

FHLB is scheduled to make an announcement on Global Notes issuance on Wednesday.

Noble expects FHLB to issue two- or three-years, based on current Libor levels, while Milstein foresees a two- or five-year offering.

"We expect them to announce for a two-year, maybe a five-year, but definitely more focused on two-years," Milstein said. "That's why the sector's a little softer today."

The coming supply, in addition to offerings by Fannie Mae and Federal Farm Credit Banks the previous week and by Freddie Mac at the start of the year, has been nudging spreads outwards, Milstein said.

"We've had a lot of supply this year," he said.

The market is also trying to digest supply on the supranational-sovereigns front and in high-grade corporates, and some money has been leaving agencies for those other higher-yielding instruments, Milstein added. But the current softening is unlikely to make a big dent in spreads, he thinks.

"I don't see a big exodus," Milstein said.

Demand in the market should also remain healthy.

"We've seen very solid demand so far this year," Milstein said. "There's been adequate demand, and interestingly we've also seen Asia coming in and taking a decent amount of the Fannie Mae and Freddie Mac issues. I do expect to continue to see that this year."

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