Agency spreads react to FOMC's 'Operation Twist'; Fannie Mae may add to supply Thursday

By Lisa Kerner

Charlotte, N.C., Sept. 21 - Agency spreads widened on the short end and tightened on the long end in response to an announcement Wednesday afternoon by the Federal Reserve's Federal Open Market Committee following its two-day meeting, according to Mary Ann Hurley, vice president, fixed-income trading, D.A. Davidson & Co.

The FOMC, as many had expected, revived "Operation Twist," a policy from more than 40 years ago.

According to news release from the FOMC, by the end of June 2012, it will purchase $400 billion of Treasury securities with remaining maturities of six years to 30 years. It will sell an equal amount of Treasury securities with remaining maturities of three years or less.

"This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative," the FOMC's news release said.

Hurley was not surprised by the Operation Twist news, although the size of the plan is larger than she had anticipated.

Over the next six months, the proceeds from agencies and agency mortgage-backed securities, or about $73 billion, will be reinvested into the mortgage-backed markets, Hurley said.

The reinvestment is expected to begin Oct. 3. The Fed will make the schedule of sales and purchases available by the end of each month.

'Lukewarm' response

Operation Twist is a bit aggressive, said Michael Skinner, director of callable agency trading, Guggenheim Partners.

"It is bigger in size than the Street would have imagined," said Skinner, who anticipated that the size would be closer to $200 billion to $300 billion.

Also, the plan includes the 30-year sector, which was unexpected.

The overall response to the Operation Twist announcement was "lukewarm," according to Skinner.

"You can't fix fiscal problems with monetary policy," he said.

While the immediate effect of the FOMC's plan will impact spreads, Hurley said the question becomes how much is the plan going to impact the economy? Housing interest rates should decline, but the jobless rate is expected to come down only gradually.

Both Hurley and Skinner found the FOMC's assessment of the economy disappointing, as did the stock market, which quickly dropped at the end of the day.

Hurley said Wednesday was "wait and see" all day, with investors holding out until the FOMC's statement.

While nobody really knew exactly what they were going to do, "most people were in the camp that they were going to do something," said Hurley.

The FOMC announcement gave a nod to European markets, noting "there are significant downside risks to the economic outlook, including strains in global financial markets."

Fannie Mae to price?

On Thursday, Fannie Mae has an opportunity to announce a Benchmark Note and add to supply.

Skinner thinks the agency may pass or perhaps do a three-year.

Hurley wouldn't hazard a guess. "I don't know what will happen," she said.

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