Agencies tighten as volumes languish; callables sluggish, but redemption reinvestments up

By Kenneth Lim

Boston, Jan. 19 - Agency spreads narrowed slightly on Wednesday on spotty trading as investors remained distracted by supply in other debt markets.

Bullet spreads closed about half a basis point tighter versus Treasuries and swaps across the yield curve, an agency trader said.

"Nothing really over the top," the trader said.

Trading volume was uneven, with occasional centers of activity scattered throughout an otherwise quiet day.

"We had some decent flows, although it was really kind of all over the board," the trader said. "Saw some interest in the seven-year sector...but on the other side, [there were] still a lot of dealers out there calling and asking, 'What's going on, it's pretty slow here.'"

Callable spreads tighten

Callables remain sluggish, although some redemption-driven reinvestments were seen Wednesday in an echo of last year's main market force.

"There was some callable buying to replace some redeemed bonds, which we hadn't seen in a while," the trader said.

Redemptions stopped at the end of 2010 as interest rates rose, giving issuers less of an incentive to refinance existing debt. But yields were pulled back down after the first week of 2011 when the year's first non-farm payrolls report came in worse than expected.

"Callable spreads are tightening because volatility has been on a one-way downward track since the non-farm payrolls," the trader said. "People have become more convinced that the range is holding, as opposed to before when people were concerned that we would go up to 4% [on 10-year Treasury yields]."

Valuations on new callable issues are "not exactly that exciting," but the tightening of new issue spreads has helped to reintroduce redemptions, the trader said.

Step-up structures are also seeing better interest from institutional investors, although institutional buyers are likely to remain highly selective about which structures they want, the trader said.

"They're being looked at more by institutional-type players rather than just what was considered a retail type product," the trader said.

Quiet week expected

The market has been quiet this week, and Federal Home Loan Banks' announcement on Tuesday that it would not issue new Global Notes in January continued to register as a disappointment.

"It was a bit ominous," the trader said. "I'm not sure how to read that, because on the one hand I thought we'd see much of the same this year [in terms of declining issuance], but they've been out of the market a couple of months here, and...they're doing stuff elsewhere where they don't have to pay fees."

The sessions heading into the weekend do not offer hope for much more action.

"I don't see a heck of a lot that's going to drive us," the trader said. "It's a light data week."

Investors are also more interested in other spread markets, where active supply markets offer discounts for those who want to maximize yields.

"Some rate buyers are moving to the sidelines, waiting for a pullback, and spread buyers have a lot of alternatives with supra-sovereigns and high-grade corporate type deals," the trader said.

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