Agency spreads soften ahead of hearing on GSEs; Freddie Mac, Fed buying weigh on spreads

By Kenneth Lim

Boston, March 22 - Agency spreads closed slightly wider on thin volumes Monday as a week of uncertainties loomed ahead.

U.S. Treasury secretary Timothy Geithner is expected to explain the administration's plans for the future of Fannie Mae and Freddie Mac to the House Financial Services Committee on Tuesday, while Freddie Mac could add benchmark supply on Thursday. The Federal Reserve Bank of New York is also scheduled to carry out its final agency debt purchase operation during the week.

Bullet spreads ended a touch wider across the curve on Monday, said Mike Goldman, head of agency trading at Guggenheim Partners. But trading activity was so light that end-of-day quotes should be taken with a pinch of salt, he added.

"There's not a lot going on," Goldman said. "They feel a little wider, but without much volume it's just quotes."

Callable issuance remains robust, however, but Goldman noted that the weakness in the previous week may have hit some investors.

"With the markets trade a little off last week, there is some stuff that's under water," he said. "So demand is off a little, guys are just working off inventories, but this will work itself out."

The market continues to be "bifurcated," Goldman added, with agency paper longer than three years underperforming shorter-dated notes.

"Clearly outside three years agencies are trading worse," he said. "Because of the Treasury's support, some people interpret that as there's no way they could fall."

Geithner wildcard

Monday's market was quiet in anticipation of testimony on Tuesday by Geithner, who is expected to lay out the White House's plans for Fannie Mae and Freddie Mac, which are under federal conservatorship.

"It feels kind of cautious out there," Goldman said. "We have testimony tomorrow on the fate of the GSEs. I think that's making some people nervous."

The testimony could go either way for agencies, and the market has received little indication of where the administration could be headed.

"If he talks about the possibility of winding down the GSEs, that's going to be terrible for agencies," Goldman said. "If he talks about putting them on the federal balance sheet, it's going to be great for agencies.

"I don't think he'll do either one, but there's always the possibility that he would send some type of message to prepare the market to lean toward either one."

The Treasury's expressed support for Fannie Mae and Freddie Mac for the next three years offers reassurance for shorter-term paper, but the protection is not bulletproof.

"It only says that if they need money, they can get it from the Treasury, but it doesn't say they can't default," Goldman said. "I don't expect that to happen, but...the point is there's a lot of uncertainty."

The fact that the House committee chairman also happens to be Rep. Barney Frank also weighs on investors. Comments by Frank on March 5 raised the specter that holders of Fannie Mae and Freddie Mac debt might have to take haircuts, forcing the Treasury to later reaffirm its commitment to the agencies.

Widening pressure ahead

Agency spreads could also be facing widening forces from Freddie Mac and the Fed later in the week.

Freddie Mac is scheduled to announce on Thursday whether it will issue Reference Notes. The Street is quiet on what it expects Freddie Mac to do, but a two-year offering is possible, Goldman said.

"It's a little early [for speculation], but they haven't done a two-year in a while," he said.

The Fed is also expected to wrap up its agency coupon buying program, which began in December 2008, later in the week. The Fed would have bought almost $175 billion of agencies.

"Once that's done, there goes the support from the government," Goldman said.

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