Agencies mixed as Treasuries cap volatile week with rebound; front-end spreads pressured

By Kenneth Lim

Boston, May 13 - Agency spreads ended mixed on Friday, with long-end securities performing slightly better as Treasury yields slipped.

"Saw some selling at the front end of the curve, especially the two-year part of the curve," one trader said. "The longer end seemed to have a stronger bid today. We sold some 30-year paper for the first time in a while, so there was some interest in that part of the curve."

Secondary trading was thin with the weekend approaching and Treasuries closing out a volatile week.

"It was very quiet today," the trader said.

Callable activity was robust, although most of the trading was in the secondary market.

"Still [there was] very good buying in callables, but the issuance pattern is very slow," the trader said. "Right now $250 million is a huge deal...You see a lot of $25 million deals instead. Getting deals done is like pulling teeth."

Although investors want new paper, issuance volumes have been capped by the lack of funding needs at the agencies.

"It's because Fannie Mae and Freddie Mac are running down their portfolios," the trader said.

Treasury yields fall again

In keeping with the week's day-to-day fluctuations, yield levels on Friday fell again as Treasuries reversed the previous session's selloff.

Key to Friday's drop in yields was a meek Consumer Price Index print of a 3.2% increase in April. Core CPI, which excludes food and energy, rose by 1.3% in April, less than the Federal Reserve's target of 1.5% to 2%.

"I think there was a bit of a sigh of relief on the Street when CPI wasn't as high as feared," a market source said. "Core CPI was up 1.3%, which means the Fed's got a bit of room to maintain its current policy of low interest rates."

The low inflation rate emboldened investors to shore up their positions in Treasuries ahead of the weekend.

"Yields have been up and down all week; we were down yesterday, so today kind of just brought us back to square one," the source said. "People were worried that CPI would show higher-than-expected inflation, but it didn't, so the market kind of just took that little piece out and got back to where it was before."

Front-end agencies did not do as well as longer securities because long-term spreads have been wider, the source said.

"It's cheaper out on the curve," the source said.

FHLB announcement ahead

The front end of the curve also came under a little bit of pressure with Federal Home Loan Banks possibly adding supply just after the weekend, the source said.

"Home Loan has an announcement on Monday, so we could be looking at some supply once we come back next week," the source said.

FHLB issued new three-year Benchmark Notes in April and could pass on Monday or do a deal in the front end of the curve, the source said.

"I'm guessing another two- or three-year," the source said. "It's a pretty cheap time to come to the market if they have the need, but that's a big if."

The source said the market probably would not be surprised if FHLB passed on the calendar slot.

"There's just no need to raise money; it's that simple," the source said. "Plus they're getting better terms in the discount notes market and callables."

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