Agencies lag Treasuries amid Freddie Mac reopening; Fannie Mae dominates discount notes

By Kenneth Lim

Boston, July 14 - Agency spreads nudged wider on Wednesday as Treasuries rallied and expected new benchmark-sized issuance from Freddie Mac failed to materialize.

Bullet spreads underperformed Treasuries by about 0.5 basis point across the yield curve, an agency trader said.

"We did get a nice Treasury rally today," the trader said.

Callables remained active following the slight uptick in yields over the past two days as investors reinvested money from old paper that had been called.

"The magnitude of the number of issues being redeemed just continued to line investor pockets," the trader said. "We had a nice pullback in yields over the last couple of days, and the Street used that opportunity to buy some coupons they hadn't seen in a few weeks."

But the rush for callables quickly pushed that segment into rich territory again.

"By 1 p.m. today after the auction and the Fed minutes, they just took off running, and now we're back to where we started," the trader said. "Now everyone's sitting on TARP paper, premium paper, and nobody really wants to chase it. A lot of people are crossing fingers and hoping that this will be a short term pullback."

Freddie Mac passes

Freddie Mac surprised the market with a smaller-than-expected reopening of five-year Reference Notes.

"The Street was looking for a two- or a three-year," the trader said.

Freddie Mac priced a $1 billion reopening of 2.875% five-year Reference Notes on Wednesday at a stop yield of 1.93%.

The stop price was set at 104.110716 through an auction. The spread was about 8 bps over Treasuries.

The auction had a bid-to-cover ratio of 3.835 times.

After the auction, the size of the debt series is now $6 billion.

The market's reaction to the offering was slightly muted as the Treasury rally offset any tightening in the two- and three-year sectors, while the five-year deal was too small to make much of a dent.

"I would have thought we'd have tightened a bit more when Freddie Mac passed on new issuance," the trader said.

Offer spreads were around 8 to 9 bps over Treasuries at the time of the auction, so the concession from the deal was small, the trader said.

"The talk on the Street was there were some shorts out there that could have used a little bit of paper to cover shorts," the trader said. "To me, it underlines the lack of Freddie Mac's current funding needs."

Investors who had been hoping for new five-year paper were not entirely satisfied with the offering either.

"It helped the Street today, but it didn't really help investors who really needed more new paper to buy," the trader said. "If they had come with a new five-year, it would have gone well."

Discount surge

Wednesday also saw a large amount of issuance at the very front end of the yield curve, mostly driven by Fannie Mae.

The mortgage agency issued about $6.5 billion of discount notes in the six-months and shorter durations, not including auctions, and about $2.2 billion of one-year notes.

"Clearly there was some rollover money in there," the trader said.

Short-term paper has been particularly attractive to investors in the past few weeks because of the additional yield pick-up they offer amid low Treasury rates.

"There has been a fair amount of buying in the one-year sector...over the last week or two," the trader said.

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