Agencies tighten as Freddie Mac sells less five-years than sought; collateral supply tight

By Kenneth Lim

Boston, April 6 - Agency spreads narrowed slightly on Wednesday as Freddie Mac priced a smaller-than-expected offering of five-year notes while Treasury yields continued to rise.

Bullet spreads tightened by about 1 basis point across the board, an agency trader said.

"I expected the two- to three-year sectors not to change so much, but we saw buying across the whole curve," the trader said.

Callables acitivity was muted, the trader said.

"Callables were quiet; volatility was fairly low," the trader said.

Trading volumes remained sluggish outside of the new Freddie Mac issue, with tight spreads and low yields giving potential buyers little to like. The market could remain quiet for the rest of the week.

"Unfortunately it's not a large numbers week," the trader said. "I would expect us to grind to slightly lower yields for the course of the week, and that should keep things relatively quiet in the callables side, and I don't expect a lot of volatility in terms of spreads."

Freddie Mac tightens on debut

Freddie Mac's new 2.5% five-year Reference Notes narrowed by about 1 bp versus Treasuries on their first day of secondary trading on Wednesday after coming at a spread of 25.5 bps.

"We thought because it was such a small deal they would tighten it, but they kept it at 25.5 [bps] and it's heading out at 24.5 [bps]," the trader said.

Freddie Mac priced the $3 billion deal on Wednesday at 99.734 to yield 2.555%. Price talk was at a spread of 25.5 bps over Treasuries.

Barclays Capital Inc., Citigroup Global Markets Inc. and UBS Securities LLC were the lead managers.

The trader said the deal attracted an order book north of $5.5 billion, so the Street was expecting Freddie Mac to sell more notes.

"I guess the agencies don't need the funding right now," the trader said. "Although it looks good in the medium term to get funding off at sub-Libor, they can get better funding in discount notes and callables and step-ups."

The trader said while front-end bullet funding levels are around 9 bps below Libor, discount notes are hovering around 18 bps below Libor and step-up products are around Libor minus 28 bps.

"There's just no comparison," the trader said. "The only reason to do bullet funding is to repay all the dealers for doing the callables and step-up stuff."

Freddie Mac's reluctance to upsize the deal reinforces the view that bullet supply will tighten.

"The supply picture is going to remain pretty tight right now, and that's going to keep agencies rich all year," the trader said.

Collateral supply stays thin

The trader said collateral supply remained hard to come by, although that could ease after about a week.

"I don't think this will continue forever, but it's not going to free up much," the trader said. "There's still an avalanche of cash out there looking for somewhere to go."

The three-year sector has been especially tight in the repo market, and that could continue to pressure three-year agecy spreads, the trader said.

"You could see threes stay hot until the middle of next week," the trader said.

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