Agencies widen as investors take profit after strong week; holiday could reduce volumes

By Kenneth Lim

Boston, Nov. 8 - Agency spreads widened slightly on Monday on slight profit taking ahead of what is expected to be a quiet week for the market.

Bullet spreads closed flat in the two-year sector but went out by about 0.5 to 1 basis point in longer maturities, an agency trader said.

"Fives and sevens were wider by about a basis point, 10s and 30s out by about the same," the trader said. "Twos and threes were pretty much unchanged. The front end is pretty stable right now."

The callable market remained slower than normal with coupons still languishing at low levels amid the recent rally in Treasuries.

"We're still a little slow in callables," the trader said. "Rates aren't as attractive right now for investors, and some dealers still have inventory that they're trying to sell, so that hasn't been a huge source of activity for the past several days."

Profit takers emerge

Monday's widening was mainly driven by profit-taking after agencies tightened for most of the past week.

The Federal Reserve's decision last week to restart its Treasury debt buying with a $600 billion program gave a boost to the agency markets on expectations that yield-starved investors would shift out on the risk curve. But investors this week may be taking a breather.

"Agencies had a pretty good run last week," the trader said. "This morning it seems like some of the excitement over [quantitative easing 2] has worn off and guys were taking profit ahead of the holiday."

The long end of the curve underperformed slightly because long Treasuries had a positive session on Monday, which flattened the Treasury yield curve.

"30-year Treasuries have been lagging, so this was kind of expected," the trader said. "Long end agencies outperformed last week, so today's widening is just a case of giving up a bit of last week's gains."

Spreads have been tight and yields at lows, which suggests that agencies are at historically rich levels, but the overall investment environment is not one that the market is used to either, the trader said.

"Who's to say what's rich these days?" the trader said. "Spreads and yields are where they are right now for very good reasons, namely the Fed buying up Treasuries and absolute rates being kept low."

The profit-taking on Monday was not cause for concern given the recent tightening, and agencies could continue to hover around current spread levels, the trader added.

"For the near term, I don't think spreads are going to wander far from where they are right now," the trader said.

Quiet week ahead

There is no major supply announcement on the calendar for agencies this week, which could depress trading volumes. The next benchmark announcement will be on Nov. 16 by Federal Home Loan Banks.

Thursday is also a market holiday for Veterans Day, which will probably thin out volumes as well.

"I'm not expecting an active week," the trader said.

The U.S. Treasury will be selling three-, 10- and 30-year debt this week, which could provide some volatility.

"The long end of the curve is going to be interesting, especially with the auction," the trader said. "You could see some tightening of spreads there if the 30-year auction doesn't go well."

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