Interest rate swappers were left guessing last week whether Fannie Mae had already entered the swaps market to rebalance its portfolio or if it would still need to receive approximately USD10 billion in swaps. The agency recently announced its assets have a 14-month shorter maturity than its liabilities. Some traders claimed swap spreads had widened last week as dealers unwound 10-year swaps, in which they received fixed and paid floating, because they think Fannie Mae had already executed its swaps plan. However, other traders said the agency still has to enter swaps and the widening is due to corporate credit weakening and the fear of war with Iraq.
Over the past two weeks five-year spreads have blown out to 64bps from 55bps and 10-year spreads have widened to 62bps from 41bps, traders said. They speculated that a portion of the widening could be pressure from dealers unwinding positions when Fannie Mae did not enter the market as expected.
This is the largest duration gap that Fannie Mae has had since 1994, said Meyrick Chapman, derivatives strategist at UBS Warburg in London. "If rates continue to fall, Fannie may want to receive in the long end of the curve, which may add to further compression in spreads," he explained.
One trader noted that swap spreads tightened a few weeks before the agency announced its plans and this could have been due to an investment bank prehedging on behalf of the agency. "When the agency made the announcement it had probably done everything it needed to do," said one trader. "The Street could have been caught."
Fannie Mae announced the duration gap, in its August financial data, earlier this month. At the time it said that its strategy is to rebalance quickly but in "a manner and pace that does not put undue demands on the market or result in measurable impacts on the costs of the instruments we use to rebalance," according to Tim Howard, executive v.p. and cfo. Howard did not return calls.
