Agency spreads unmoved as investors wait for Fannie Mae; Fed buys 27.2% of offered paper

By Kenneth Lim

Boston, March 9 - Agency spreads ended flat on Tuesday as investors stayed on the sidelines ahead of expected supply from Fannie Mae, while the Federal Reserve Bank of New York completed its second-to-last purchase operation.

Bullet spreads closed unchanged after a quiet session, although there appeared to be some early interest in five-year paper, said Mike Goldman, head of agency trading at Guggenheim Partners.

"I'd say it was unchanged to maybe a drop tighter in some areas," he said. "The two-years came back out a little after the buybacks."

Callable issuance remained brisk, with step-up structures accounting for the bulk of the business.

"Step-ups keep chugging along," Goldman said. "It's just not going to change until we see a change in the interest rate policy. It's kind of matching the yield curve."

Fed buys at short end

The Fed bought $1.5 billion of agency notes due March 2011 to March 2012 on Tuesday as part of its purchase program.

The acceptance rate was 27.2% of the $5.52 billion of notes offered, slightly below the 30% rate of the past few weeks.

"There was some action this morning, particularly in the front end surrounding the Fed's purchase," Goldman said. "There's always some jockeying going on there."

Another trader said the acceptance rate was slightly disappointing because investors had expected them to buy more.

"They have the authority to buy up to $175 billion," the trader said. "Including today's buyback they've only bought about $169 billion so far, and they only have one more buyback left. I think investors were hoping that they would buy a little more because at this rate they're not going to hit $175 billion."

The trader did not think that the Fed would extend the program if the full $175 billion is not used up.

"I think the Fed's been pretty consistent in saying they expect it to end by March 31," the trader said. "I don't think they have much room to extend it anymore because they're already holding on to so much of the market. I'd say any extension would be a surprise on the upside, but I don't think the market's pricing in that expectation."

Fannie Mae announcement expected

Fannie Mae could announce an issuance of Benchmark Notes in the two- or three-year sectors on Wednesday, the traders said.

Goldman said Fannie Mae looks like its still has funding needs, so an offering is likely. A new three-year offering or a reopening of two-years is possible, although Goldman said he was leaning toward a new three-year deal.

"I don't think they'll do a five-year because they just reopened them, and on a Libor basis it's a little too cheap for where they usually like it," he said.

The other trader thought a reopening in the two- or three-year sectors is more likely.

"They just did a pretty big two-year two weeks ago, so I don't see them doing what would essentially be a repeat," the trader said.

Goldman said the market will be watching the Fannie Mae issuance as an indicator for how the week will perform.

"I think tomorrow's issuance is key," he said. "A new issue that grows to $4 billion or $5 billion, it could weigh on the market heavily, especially with the Fed extricating themselves. For the agency market here it's going to be finding a new buyer."

A big offering could still do well, "but I think it would have to come at [a] cheaper spread," Goldman added.

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