Agencies widen on profit-taking as yields hover near lows; downgrade fears hit spreads

By Kenneth Lim

Boston, Aug. 5 - Agency spreads widened on a rocky Friday as swap spreads widened modestly and profit-takers cashed in on low yield levels.

Bullet spreads shifted out by about 2 basis points in the two-year sector and by about 3 bps to 5 bps in the long end of the yield curve.

"Not too good today," a trader said. "Everything was wider, wider, wider."

The callable market was more robust, with investors trying to lock in higher yields after the recent rally in Treasuries.

"We're printing callables," the trader said. "We're seeing a lot of long-end callables come into the market and step-up type trades. We had a pretty large auction from [Federal Farm Credit Banks] today and [Federal Home Loan Banks] as well."

Callable demand is quite well distributed across the yield curve.

"We're actually seeing buying across the curve," the trader said. "A lot of people like to shoot for the magic coupon of 2%, but you have to go out to six years for that. Some people want a 3% coupon, and that's at the eight-year part of the curve. Accounts are using step-ups in the long end to take some short duration and grab some yield."

Yields rise on profit-taking

Profit-taking was seen as the main driver of Friday's sell-off, with yields rallying sharply in the run-up to the weekend.

There was also a rumor in the day that Standard & Poor's, the last of the three major rating agencies that has yet to give an opinion on the debt reduction bill that was passed in Washington earlier in the week, would downgrade the rating for U.S. government and agency debt.

"There were rumors of an S&P downgrade, and that may have had some people cutting back on agencies," the trader said, although in theory an identical downgrade of U.S. and agency debt should not widen agency-Treasury spreads by much.

Some of the economic pressure that pushed yields to lows over the past week also eased on Friday, after the employment situation report showed a better-than-expected increase in non-farm payrolls in July.

Non-farm payrolls rose by 117,000 in July, better than consensus estimates of around 75,000. The Street in fact had a "whisper number" of a slight decline in payrolls, said Action Economics' managing director of global fixed income analysis, Kim Rupert.

Modest rebound possible

Agencies could enjoy a slight rebound after the weekend when cooler heads prevail, the trader said.

"I guess a lot of it was profit-taking," the trader said.

A downgrade by S&P would hit spreads, but some investors could be waiting for an opportunity to pick up more paper.

"If there's any kind of sell-off, some accounts will come in to buy," the trader said.

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