Agencies unchanged as wary investors hold ground; market eyes Wednesday's Fed statement

By Kenneth Lim

Boston, Nov. 1 - Agency spreads closed flat on Monday as investors avoided making big bets ahead of possible monetary stimulus by the Federal Reserve later in the week.

The market opened unchanged from where it closed before the weekend but then saw some buying in the three- to five-year sectors, said Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial. The two-year sector came under a little bit of pressure on profit taking.

"Most of the curve was unchanged, with the three- to five-year sector maybe half to 1 basis point better," Riley said. "Late in the day there was decent buying in the five-year sector. The long end is probably a tad weaker, but not by much."

Callable issuance was mostly from reinvestments of recently called paper, "which has become a business of its own" amid the high volumes of called paper, Riley said.

Issuers have been choosing to redeem their older debt as soon as they can in order to take advantage of the current low interest rate environment. And investors whose notes get called are eager to put the money back into the callable market.

"Every time something gets called, a new bond comes," Riley said. "Our new issue guys...they just continually sell to a lot of these smaller broker-dealers or smaller regionals."

Low volumes

Trading activity was on the quiet side on Monday, which was typical for the time of the week.

"It was a little quiet today, but lately Mondays and Fridays have been very quiet for whatever reason," Riley said. "It's like the market's now on three-day weeks."

Anticipation of the Fed's Tuesday-to-Wednesday meeting was also keeping money on the sidelines. The Fed is expected to announce on Wednesday that it will aim to buy government debt from the market.

"Everyone's patiently waiting for Wednesday to see what the Fed's announcement will be," Riley said. "I don't anticipate a lot of activity before Wednesday's announcement."

Yields under pressure

The agency market is at historically tight levels, and if the Fed begins to take Treasury debt out of the market, that could create an environment for agencies to underperform Treasuries. That could be a healthy correction for agencies, Riley said.

"Agency spreads could widen a tad," Riley said. "We've come in an awful long way, obviously, and as you take Treasury paper out of the market obviously that will cause agencies to widen...but I don't think that's a negative."

On the other hand, absolute yields could nevertheless fall even as spreads widen because of the Fed's easing action.

"I think everything is moving to lower absolute yield levels," Riley said.

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