Agencies track Treasuries higher amid Europe concerns; Fannie Mae offers five-year notes

By Kenneth Lim

Boston, Aug. 16 - Agency spreads closed flat on Tuesday as Fannie Mae announced an unexpected offering of five-year debt and as concerns about Europe drove yields lower.

Bullet spreads closed the day unchanged versus Treasuries, although swaps narrowed a touch in the 10-year sector. In terms of the recent trading ranges, spreads are near the tights, having come in about 7 basis points to 8 bps in the five-year sector since a week ago.

"Spreads are pretty much unchanged," said Michael Skinner, director of callable agency trading at Guggenheim Partners.

The callable market was active on the back of a brisk rate of redemption amid expectations that short-term interest rates will remain low for the next two years.

"A lot of activity in callables today," Skinner said. "A lot of stuff [was] called away after the Fed's announcement last week - $22 billion called away last Thursday and Friday and more called since then. A lot of people need to put money to work."

Step-up structures are still popular products, but investors are also now willing to take slightly lower coupons in order to get longer call protection.

"I've seen a lot of guys lately looking for longer lockouts," Skinner said. "If they can get six months or one year, they'll get one year because they don't want to get called and have to do this all over again."

Europe concerns hit yields

Yields reversed Monday's gains on Tuesday, falling on renewed concerns about Europe's credit stability following weak economic data from Germany.

Germany's economy grew by just 0.1% in the second quarter of the year, raising doubts about the ability of Europe's largest economy to continue providing bailout funding for the continent's weaker economies.

An announcement by German chancellor Angela Merkel and French president Nicolas Sarkozy calling for closer fiscal unity in the euro zone failed to calm investors, who viewed the move as lacking in details.

"Basically the market was disappointed," Skinner said. "They were hoping for a little bit more clarity, but they were left with a big shade of gray. If you've learned anything from the past few weeks, it's if you give the market a shade of gray, they're going to react negatively."

Fannie Mae plans five-years

Fannie Mae on Tuesday said it will offer new five-year Benchmark Notes, talked at a spread of 35 bps over Treasuries.

The size of the deal has not been set, but it should be at least $3 billion.

Barclays Capital Inc., J.P. Morgan Securities LLC and UBS Securities LLC are the lead managers.

A five-year deal surprised the market, which was largely expecting something closer to the front end of the yield curve or a pass.

"I just felt like with all the volatility if they were going to come at all they were going to go with a two- or three-year," Skinner said.

Price talk represented a modest concession of about 1 bp to surrounding issues, but 35 bps over Treasuries "seems right in line," he added.

"It should go pretty well," Skinner said.

The outlook for benchmark bullets is also healthy, with the agencies facing shrinking funding needs.

"I do like the story of benchmarks going forward because supply will be somewhat limited in benchmark size," Skinner said.

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