Agency spreads widen as supply arrives; Freddie to tap market hunger for new five-year bullets

By Kenneth Lim

Boston, Sept. 8 - Agency spreads continued to soften against Treasuries on Wednesday as Freddie Mac announced supply in the five-year sector.

Despite increases in Treasury yields, bullet spreads widened a touch as swaps also lost ground against government bonds.

"We were a little wider today, but not exceedingly so," an agency trader said. "We outperformed swaps by maybe 0.5 basis point, but we were a little wider against Treasuries."

The market's weakness was limited by the busy primary market across the fixed income spectrum, the trader added.

"Normally we're tightening on the way up [in rates], but what's helping spreads as well is all those jitters in Europe kind of dying down and a lot of new issues, which is keeping bids in swaps," the trader said. "It's been pretty big in supply."

The callable market came back to life as the back up in rates opened a window of opportunity for issuers to offer aesthetically pleasing coupons.

"There were some callables today just on the back-up in yields over the course of the last week or so," the trader said. "We're a little bit weaker than we were, so on any back-ups guys use the opportunity to do some new issue stuff. Everyday we get deals from [Federal Home Loan Banks] and [Federal Farm Credit Banks], but these back-ups give the opportunity for clients to get what they're looking for rather than just the reverse inquiry stuff."

Freddie Mac plans five-years

Freddie Mac said it will sell new five-year Reference Notes on Thursday.

Price talk was at a spread of 29.5 basis points over Treasuries, after having been tightened from initial talk of a 30 bps spread, market sources said.

The size of the offering has not been set, but it is expected to be at least $3 billion.

Barclays Capital, Inc., J.P. Morgan Chase, and Citigroup Global Markets are the lead managers.

Demand for the offering was strong amid a general lack of supply in the five-year region. The order book had reached around $7 billion as of the close Wednesday, the trader said.

"Books look to be in good shape, orders over $7 billion," the trader said. "But it's probably going to be around $3 billion to $4 billion."

Freddie Mac may not issue much more than the minimum benchmark size of $3 billion because it does not have strong funding needs, the trader said. Nevertheless, demand is strong, and it allowed Freddie Mac to tighten price talk even though five-year spreads were wider on the day.

"That works out to about Libor plus 11 bps, 1.5 bps cheap to the curve," the trader said. "Even though agency swaps haven't come in, I guess they tightened it just on the size of the order book."

The trader was pleasantly surprised by the announcement, having expected an offering of new two-year notes or a reopening of an existing three-year series.

"It's welcome supply," the trader said. "There's none of it around."

Busy Thursday

The trader expects market activity to pick up on Thursday with the last major economic calendar event of the week.

"We have trade balance tomorrow, and on Friday nothing," the trader said. "Tomorrow might be a little busier, and Friday a little quieter because tomorrow's going to be the last opportunity to get something done before it goes quiet."

The new five-years on Thursday could also spur some trading.

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