Agency spreads narrow as investors seek value before holiday; slight correction possible

By Kenneth Lim

Boston, Nov. 24 - Agency spreads continued to contract on Tuesday as investors tried to get their trading done before the holidays.

Bullet spreads were tighter by about 1 to 1.5 basis points across the yield curve, an agency trader said.

"We outperformed Treasuries pretty much in all sectors of the curve," the trader said.

Volumes were robust as investors tried to get one last bit of action before Thursday's Thanksgiving holiday. The market will be open on Wednesday, but most desks will see only light action, the trader said.

"I guess from a buying standpoint it was pretty quiet, but we do a lot of swaps and a lot of people are doing swaps before year-end," the trader said.

The Federal Open Market Committee on Tuesday also released minutes of its Nov. 3 to Nov. 4 meeting, but it held no surprises for the market, the trader added.

"There was nothing new that we didn't already pick up," the trader said.

Agency value

Tuesday's tightening continued what has been just over a week of contracting spreads. Investors have been flocking to agencies to pick up what they perceive as value in the investment class, the trader said.

"Agencies right now seem to be one of the cheaper products on the curve," the trader said. "They're a lot cheaper than mortgage-backed right now, and we see people selling mortgage-backed and going into agencies."

Investors are also expecting agency spreads to tighten more than other spread products such as corporates, the trader said.

"Spread compression with credit products are going to be less than what we see in agencies," the trader said.

Potential widening

Although agencies are still not trading at historically rich levels, spreads could be poised to ease back out before the end of the year, the trader said.

"We are probably due for some kind of correction," the trader said. "Swaptions have come down so much, going into year-end, we should see some widening. I would anticipate...swaption volatility is going to be picking up somewhat."

But the rest of the holiday-shortened week should see spreads continue to come in despite low volumes.

"My guess is tomorrow will be very quiet," the trader said. "My guess is for the rest of the week, I guess it would continue to tighten a little. A lot of firms are on calendar year-end, so you try to go into year-end pretty light."

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