Agencies narrow on month-end extension, position squaring; penalty for agency fails sought

By Kenneth Lim

Boston, April 29 - Agency spreads tightened on Friday amid a rash of month-end extension buying and position squaring.

Bullets closed the day about 2 to 3 basis points narrower versus Treasuries, an agency trader said.

"Agencies had a grab fest today," the trader said. "They were better by about 2 to 3 basis points on the day."

Trading volumes picked up after being quiet in past weeks, as investors rushed to get their business done before the month closes.

It was a "very active day, which was a nice surprise," one source said. "It's a good way to end the month."

Callable trading was decent, but less robust than usual because of the rally in Treasuries, the source said.

"I think the callable investors would rather wait for yields to go back up before stepping in again," the source said.

Month-end buying

Friday's strong buying was largely a function of the month end as investors tried to dress up their portfolios, the source said.

"Some people had to get stuff done before the weekend and knowing that it could be tough to get some trades done next week because of the May Day holiday in the rest of the world," the source said.

The agency trader said there was a "fairly good size" extension trade on Friday that led to some buying in the belly of the yield curve.

"It started about 10 a.m. and ran right through lunchtime," the trader said. "There was a month-end extension that explained part of it."

The trader said there may also have been a slight knee-jerk reaction to the Treasury Market Practices Group's recommendation on Friday to implement fails charges of as much as 3% on agency and agency mortgage-backed securities trades.

The TMPG, an advisory body formed by the Federal Reserve Bank of New York and comprising industry members, said the fails charges were aimed at reducing the exposure to high levels of fails.

One concern is that overly heavy penalties for fails could lead to short squeezes, where investors hoard securities.

But the trader said the actual implementation of the recommendation is still a long way away, and the TMPG announcement probably had only a minor role in Friday's buying.

"That's a long way in the future," the trader said. "I don't think that was the reason for it."

Dealers may also have been trying to square up their positions after overcompensating for the past week's supply - the Treasury sold $99 billion of notes, while Freddie Mac passed on an issuance date.

"I think the Street had to get paper back for customer volumes," the trader said.

Fannie Mae ahead

The week ahead could see some supply from Fannie Mae, which is scheduled to make an announcement on Benchmark Notes on May 3.

"I could see it going either way," the source said. "They could come with a three-year, but if they don't need the funding they can just wait one week and do it on May 11."

The market is getting used to the agencies skipping calendar dates by now, the source said.

"We're in a different time now," the source said. "We're no longer living in the days when they would use every slot they had. It explains why spreads are so tight these days and why the market's not as liquid as it used to be."

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