Agencies continue underperformance as Treasuries stage comeback; volatility takes toll

By Kenneth Lim

Boston, Nov. 18 - Agency spreads continued to widen on Thursday as Treasuries experienced some late bargain hunting.

"We are wider from yesterday's levels by about 1 to 2 basis points across the board from two-years on out," said Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial. "It's not unusual to see agencies widen out when Treasuries rally."

Treasury prices slipped for most of the day, before pulling almost even in the afternoon on late buying.

Agency trading volumes were decent, with a good balance of buyers and sellers.

"The market feels OK," Riley said. "Supply is there, and we expect more next week. Flows have been decent, but when there's a lot of volatility it's hard to know which way the market's heading. Today was probably evenly matched between real money buyers and sellers."

Rough ride

The agency market has been having a tough week amid the volatility in the fixed income markets.

"It's been a rough ride this week," Riley said.

The Federal Reserve's $600 billion quantitative easing policy is the main root of all that uncertainty in the market, he added. Expectations that the central bank would start to buy Treasury debt helped spreads to tighten and yields to fall before November, but since then investors have toned down their enthusiasm over the impact of the purchases. Adding to the pressure, some critics are also calling on the Fed to reverse its decision on the buybacks.

"It's been a combination of the buyback from the Fed and the negative response, which was kind of surprising to most of us," Riley said.

Waiting for stability

Agency investors appear to be waiting for the markets to calm down before committing to a position, because high market volatility makes it hard to figure out what should come next.

Furthermore, the investors who thrive on volatility are more focused on Treasuries instead of agencies at this time.

"Fast money has really left the market," Riley said.

When the dust settles down, the tone in the agency market should improve, he added.

"Eventually we will see lower outright yields," Riley said. "Let's put it this way. Every issue that comes is well oversubscribed and very well received, regardless of where the market is at any given time. So clearly there's a lot of demand for agency paper."

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