Agencies inch closer to Treasuries after volatile session; markets eye Fannie Mae supply

By Kenneth Lim

Boston, Feb. 25 - Agency spreads narrowed slightly on Friday after a rocky session as Treasuries continued to rally.

Bullet spreads tightened versus Treasuries, with longer maturities outperforming slightly, said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott.

"It was kind of a volatile day for the agency market," he said. "The yield curve was changing shape a little bit here. We have seen agency spreads tighten up against Treasuries, especially on the long end of the curve."

Trading volumes continued to struggle, a blemish on the market's recent tightening.

"We got the holiday weekend last weekend, and that was kind of an excuse for slower activity throughout the week," LeBas said.

LeBas did not think that the two-week-old White House paper to Congress on the future of Fannie Mae and Freddie Mac, which led to spread tightening, was a major reason behind the thin trading.

"There wasn't anything in the white paper that told me volumes should decrease," he said. "But I think obviously in the long run it does imply that agency supply will slow down or go away."

Callables also had a quiet session.

"The callable market has been pretty quiet," LeBas said. "If you look at new issues printed today, the numbers were certainly down. I'm seeing 1.5 pages of new issues, compared to three or four pages on an average day. It's also a little bit late in the month for the bank bid in callables to come in."

Spreads hold ground

Agency spreads held firm on Friday even as yields took an uneven path during the day.

Yields rose early Friday before reversing course after the government revised fourth-quarter gross domestic product growth to an annualized 2.8%, from the initial 3.2% estimate.

The ongoing unrest in Libya and in the Middle East also kept the fire going under the flight-to-quality bids that have been pushing yields lower over the past week.

But agencies have managed to stay close to Treasuries amid the turmoil.

"They've held on very well in this risk-aversion trade," LeBas said. "I think part of the reason is credit risk being priced into the Treasury markets that wasn't there a few months ago.

Fannie Mae ahead

Investors are now looking toward possible supply on March 1 with Fannie Mae slotted to make a calendar announcement on the issuance of Benchmark Notes.

The agency skipped its previous calendar slot on Feb. 9. Fannie Mae last sold Benchmark Notes on Jan. 28 in a $5 billion offering of three-year paper.

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