Investors are going to face a shortage of very high quality short-end paper. This is because there is much less being issued than will be maturing through the end of next year, Amherst Securities Group (ASG) said in a report released late yesterday. 

The phenomenon reflects the Temporary Liquidity Guarantee Program's (TLGP) paper's maturing as well as the short agency debenture's shrinkage, which is a result of smaller GSE portfolios.

Meanwhile, the growth of 'AAA' and 'AA' corporate paper has been modest, not nearly high enough to offset the TLGP paper's and short agency debentures' contraction.

Because of this, ASG analysts think investors will likely look into owning short agency CMO paper and they expect the paper to tighten in response.

As background, the TLGP was one of various emergency programs established in 2008 to respond to the global financial crisis. It allowed eligible financial institutions to issue senior unsecured debt in the form of fixed-income bonds that are guaranteed by the Federal Deposit Insurance Corp. (FDIC).

The program was intended to offer locked-in, low-cost funding to banks after the disruption of the interbank and short term credit markets to encourage lending to consumers and business entities.

Although these bonds are not direct U.S. Treasury obligations, they have the U.S. government's full faith and credit guarantee, since the FDIC is a government agency.

Analysts said that currently CMOs look fair to passthroughs, thus significantly expanding the choices for short alternatives.

They concluded that  short CMOs generally provide buyers with a far greater array of choices in the 1.5–3.25-year duration bucket versus those available in the collateral markets.

Additionally, these CMO alternatives are available with lower coupons, thus have lower dollar prices than their collateral alternative counteparts. This makes CMO collateral a better fit for many investors. Given the scarcity of short, high-quality Treasury alternatives resulting from the TLGP bonds maturing as well as the lack of agency debenture issuance, ASG analysts think that short CMOs will get considerably richer over the next six months.

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