Freddie Mac's first two-year reference note sale of the year last week ended up hugely oversubscribed, as overseas investors bought more than 50% of the $4 billion in notes issued.

"Generally, our reference notes tend to be about two-thirds U.S. to one-third overseas investors," said Sharon McHale, a spokeswoman for Freddie Mac. "Yesterday's was actually 56% overseas, and that included real strong representation both from East Asia and Europe." Asia represented 31%, while Europe took 25%.

The transaction was 70% oversubscribed, as the agency reported $6.8 billion in orders for the issuance. "If it's not the record, it's right at it," McHale said. "We were actually thrilled."

Settlement for the 6.625% notes due Aug. 15, 2002 is Aug. 14, 2000. The issue priced at 99.843 to yield 6.71%. Joint lead managers for the sale included Deutsche Bank Securities Inc., J.P. Morgan and Merrill Lynch & Co.

As last week's well received issuance of Fannie Mae two-year benchmark notes showed, two-year bonds are highly in favor by international investors. "Usually, they are largely Treasury substitutes," said David Montano, a director of research at Credit Suisse First Boston. "A lot of people who buy two-years hold to maturity. They're not as concerned about liquidity in the sector and they gain the extra spread over Treasurys. So there's always been a very good demand in two-years." He added that for that reason, two-years also trade tight to swaps.

Freddie Mac has no current plans to reopen its two-year notes, but it could change, McHale said. The agency's next scheduled sale is a 10-year issuance reported to settle Sept. 22.

Higher Coupons Underperform

Elsewhere in the market, mortgages have outperformed Treasurys by four to seven ticks last week, with higher coupon securities underperforming.

"Fannie 8.5s have really underperformed this week," said Rob Huntington, a mortgage-backed securities trader with Credit Suisse First Boston. "So the up-in-coupon trade looks very attractive."

He noted that higher coupons just haven't done well, but there was some buying after last Wednesday's bond auction, with more than $1 billion in volume last Thursday.

However, bank buying has stayed away from current coupon, and remained mainly with discount coupons. "I expect to see some banks coming in pretty soon," Huntington added.

August May Be a Good Thing

With August having the most business days of the summer, and mortgage rates about 50 basis points lower than they were when summer began, now is a good time to watch the housing market for a possible September refinance period and additional MBS issuance.

"We still have all kinds of parts of the country with hot markets," said Linda Lowell, a senior vice president and head of research at Greenwich Capital Markets. "We have got enough inventory in general available in the housing market, so that if mortgage rates go down a little bit, I certainly would expect the turnover to go up."

She noted that without housing turnover, little possibility exists for an extensive amount of MBS issuance. As August rolls on, market observers will be able to tell whether the housing market is still continuing a historically high pace. And if rates come down, Lowell noted it could make holders of discount securities "happier."

In addition, the lower long-term rates has not trickled down into the adjustable-rate market, indicating that future supply will favor fixed-rate mortgages.

"In a subtle way, the climate has turned more positive for more supply in the fall - more prepayment in higher coupon, shorter duration on the higher coupon. It's subtle, but it's a different value picture from June," Lowell said.

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