Agencies lag Treasuries, swaps as yields fall; Fannie Mae sees demand for three-year paper

By Kenneth Lim

Boston, May 11 - Agency spreads widened slightly on Wednesday as Treasuries rebounded and Fannie Mae announced supply in the front end of the yield curve.

Bullet spreads closed the day about 1 basis point wider versus Treasuries. Agencies also softened against swaps, but to a lesser extent.

"It looks like agencies in general softened just a little bit, which was kind of in line with swaps," an agency trader said. "The Treasury rally obviously led the spread curve to kind of soften against it."

Fannie Mae plans offering

Fannie Mae saw strong initial demand for its planned offering of three-year Benchmark Notes, which is scheduled to price Thursday.

Price talk is at a spread of 20 bps over Treasuries, sources said. The size of the deal has not been set, but the agency will probably sell at least $3 billion of notes.

Barclays Capital Inc., Goldman Sachs & Co. and J.P. Morgan Securities LLC are the lead managers of the offering.

The trader, whose firm was among the selling group, said his allotment was filled by mid-morning.

"We kind of blew out our allotment pretty quick," the trader said. "My understanding is it's getting very, very strong demand."

Price talk represents a concession of only about 1 bp to surrounding issues, which are trading at spreads of around 20 bps bid, 19 bps offered.

"It's kind of the part of the curve that I think is tracking a fair bit of money right now," the trader said. "The level is fair versus surrounding issues...it's not much of a concession against the curve, but there is a maturity gap there."

Despite the aggressive pricing, the market is still keen on that part of the sector because the curve is fairly steep around the three-years and offers attractive roll-down opportunities.

"It's around the steepest roll-down period, and it's a small enough duration that people aren't too afraid of picking it up," the trader said.

The trader expected the deal to eventually fall between $3 billion and $4 billion, even though Fannie Mae could probably upsize the offering to a larger amount.

"Obviously their needs are less than they were, and the funding levels have cheapened to the point where it's just not as attractive," the trader said. "They can get a ton of stuff done in the front end in the 'discos.'"

Yields fall again

Beyond the Fannie Mae deal, the agency market on Wednesday watched yields fall again as Treasuries reversed Tuesday's small sell-off to resume the relentless climb in government bond prices.

The callable market slowed down in reaction to the day's decline in yield levels. Callable buying had picked up over the past few sessions and was actually healthy in the morning as Treasuries initially continued Tuesday's retreat. But Treasuries rallied in the afternoon, leading to a knee-jerk pullback by callable investors.

"The move higher in Treasury prices I think caught some dealers off guard a little bit, and when prices rallied callables quieted down," the trader said.

Investors are increasingly shifting to alternative price structures, such as step-ups, from plain vanilla products, the trader said.

And although low yields are discouraging investors from buying new products, they are also fueling more redemptions, which could build up demand for the product.

"The more we stay at these levels, the more we're going to see redemptions, and investors are going to have more money to reinvest because of the money they get back," the trader said.

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