Agencies widen as non-farm payrolls fall far short of expectations; spreads could tighten

By Kenneth Lim

Boston, July 8 - Agency spreads widened versus Treasuries on Friday as a shockingly weak employment situation report sent yields collapsing across the curve.

Bullet spreads closed the day out by about 1 basis point versus Treasuries and flat against swaps.

"The big thing was the [payroll] numbers, which blew out spreads along with swaps," an agency trader said. "We went out about 2 bps across the curve, but later in the day it kind of normalized and spreads actually came back in about 1 bp, straight across the curve."

The day's turbulence kept callable demand muted.

"I'm not sure if it was Friday related or the numbers and the widening, but callable issuance was also down today," the trader said.

Payrolls fall far short

Investors fled toward safe-haven assets after the Labor Department gave an employment situation report that fell way below Street expectations.

Non-farm payrolls in June rose by just 18,000, while the number of jobs created in May was revised downward to 25,000. The unemployment rate rose to 9.2%.

"I think it kind of caught everyone off guard," the trader said.

Investors had been expecting a much better report, with the consensus on the Street hovering around 105,000 new jobs. The market's hopes had been raised following improved housing and business indicators leading up to Friday's report, as well as a surprisingly strong ADP National Employment Report of private payrolls on Thursday.

The sheer extent of the miss led to a rush for Treasuries. Agencies were left behind initially but managed to close the gap later in the day.

"Treasuries raced up, but once everything settled, agencies were actually not that far out," the trader said.

Most of the trading was in on-the-run issues, although off-the-run paper mostly mirrored movements in the newer issues.

"It was all on-the-run trading, but off-the-runs kind of moved along in tandem," the trader said.

Possible tightening ahead

The kneejerk selling on Friday could have been overdone, the trader reckoned. Freddie Mac's new 2% Reference Notes due August 2016, in particular, widened from its initial 32.5 bps spread despite looking cheap.

"I'm surprised they're out this wide, especially the new five-years," the trader said. "Those are already underwater by 1 bp, and they were already pretty cheap to begin with. I think spreads should start coming back in next week."

The callable market could also see better demand if yields remain too low.

"The tighter the yield gets, the more these guys need these issues because they can lock in the yields," the trader said. "People are going to be grabbing for more yield."

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