Agency spreads narrower at short end, wider farther out; Q4 could see widening, trader says

By Kenneth Lim

Boston, Oct. 1 - Agency spreads were mostly unchanged Thursday with the Treasury market dominating the high-grade fixed-income space, market sources said.

Bullet spreads were seen slightly narrower in the shorter end of the yield curve, said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson & Co.

"Spreads were unchanged to a little narrower," she said.

Volumes were light, as they had been for most of the week.

"It's really pretty quiet," Hurley said. "It's been a pretty light week. We had a lot of callable issuance, and we had some trading on the short end of bullets, but I think at this point people are waiting for tomorrow's report on non-farm payrolls."

But Hurley acknowledged that the payroll numbers will probably have a small impact on agencies.

"In terms of spreads in agencies they are probably not as significant," she said. "It's more for Treasuries."

Another agency trader said spreads had widened farther out on the curve because of profit taking.

"We've seen some selling on the long end, just some guys selling because we're so rich right now," the trader said.

But the trader agreed that most of the market's attention was firmly fixed on Treasuries.

"In spread products there's a lot of apathy right now," the trader said.

Fed buys five-years

The Federal Reserve Bank of New York's weekly purchase operation gave the agency market most of its action on Thursday, but even that action did not stir the pot.

"They bought 45%, which seems to be what they've been buying, so no surprises," the trader said. "They did exactly what the market was hoping for."

The Fed bought $2.635 billion of agency paper due 2013 to 2016, representing 45% of the $5.855 billion of securities offered.

The Fed has now bought about $131 billion of agency debt as part of its open-market operations. It expects to buy up to $200 billion by the end of the first quarter of 2010.

Cantor Fitzgerald chief fixed-income rates strategist George Gonzales noted that the biggest purchase on Thursday was in the recently reopened five-year notes from Fannie Mae and Freddie Mac.

"The next largest purchase was in the 6-7 year part of the curve which trades rich (but less rich versus the alternatives in this bucket)," he wrote in a research note. "Moving back to the larger issues and recently issued bonds makes sense from a liquidity standpoint as well as helps keeps the market dynamics intact."

Wider quarter possible

The agency trader said Friday will probably be another quiet day for spread products with a lack of market catalysts on the calendar.

The rest of the quarter could see spreads widen slightly.

"Normally at the end of the year we'll see spreads widen a little, and we've had a strong tightening this year, so I think we could see some widening," the trader said. "Unless we have such a large move in Treasuries that we see the convexity guys come in and bid."

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