Agency spreads widen on credit weakness; Fed buys five- to seven-years in small operation

By Kenneth Lim

Boston, Dec. 21 - Agency spreads widened slightly on general weakness in credit markets on Monday, while the Federal Reserve Bank of New York had its smallest purchase operation of the year.

Bullet spreads inched out a little on the day, said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson & Co.

"Spreads are a little bit wider, by 1 to 1.5 basis points," she said. "Activity is very, very thin."

Yields increased relative to Treasuries partly because of a general dullness in the market, Hurley added.

"Just weakness in the market," she said. "The Fed's agency buyback today was weak as well, and [there was] just a lack of volume."

Another agency trader said the end-of-day spreads should be taken with a grain of salt, given the light volumes on Monday.

"Just looking at spreads, it's a little wider, but there was so little trading going on today I don't know how reliable those numbers are," the trader said.

Fed buys at belly of curve

The Fed on Monday bought $490 million of agency notes in the five- to seven-year sectors as part of its outright coupon purchase program.

The amount purchased represented about 25.2% of the $1.946 billion tendered and was the smallest action, in notional dollars, by the Fed this year.

Hurley said investors were not surprised by the small size of the operation, given the holiday week, but some in the market may have been hoping for more.

"Given the tone in Treasuries, I think people thought that it would be a little stronger than what it did," she said.

The other trader noted that the 25.2% acceptance rate was the lowest since the Fed began to reduce the size of its weekly purchases.

"A few days ago it was 30%," the trader said, referring to the Fed's $1.704 billion action on Dec. 18. "I mean we already know they're going smaller and smaller, so it's not a big surprise. But I think it just reinforces the fact that the Fed's well on its way out of the market.

"They could have easily bought 30% if they wanted to, it's not like they received $10 billion of offers, but they're clearly sticking to whatever schedule they have."

Year's end in sight

Neither Hurley nor the trader expects the Fed to carry out another operation for the remainder of 2009.

The trader said the market was now well in "twiddling thumbs" season.

"The Fed buyback, that's really the last event for the market this year," the trader said. "That's the final bell. If the Fed got a few billion of tenders, that would have been a surprise and I would have said, OK, maybe there are still some people hanging around. But $2 billion? It's time to pack up early."

The rest of the week will only get quieter, the trader said.

"I don't expect to see any more than today," the trader said. "There's absolutely nothing happening from now on. You don't even have to come in on Thursday."

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