Agencies unchanged in quiet session; investors hunker down for supply, volatile week ahead

By Kenneth Lim

Boston, Nov. 19 - Agency spreads took a breather from a week of widening to close flat on Friday as investors braced themselves for supply.

Bullet spreads ended the session unchanged after widening for most of the past week, said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson & Co.

"For the most part spreads are pretty much unchanged," she said.

Trading volumes were light on a slow news day for economic data. The callable segment was also affected by the slowdown.

"Market activity is a lot slower today than earlier in the week, and there was a lot less issuance today," Hurley said.

The bulk of callable issuance continues to be in step-up structures, she added.

Volatile week eyed

The agency market ended the week lower than when it started and wider versus Treasuries. The volatility has its roots in the market's uncertainty about the impact of the Federal Reserve's $600 billion quantitative easing program to buy Treasury debt.

"I think that the whole fixed income market right now is just trading in a very, very volatile fashion," Hurley said. "It remains unclear whether the recent moves by the Fed will spark a pick-up in growth and inflationary pressures."

The Fed's ability to achieve its aim is a big question mark that will keep volatility at elevated levels for a while, she added.

"Frankly interest rates are higher than when the Fed announced [quantitative easing]," Hurley said.

Heavy supply ahead

Investors will return after the weekend to a busy week for Treasury supply.

The U.S. Treasury plans to auction $35 billion of two-year notes on Monday, $35 billion of five-year notes on Tuesday and $29 billion of seven-year notes on Wednesday before the Thanksgiving holiday on Thursday.

"We have a lot of supply next week that's going to be undertaken prior to Thanksgiving," Hurley said. "We've gotten a price concession, but prices are still very expensive relative to earlier in the year. By the same token, you have the Fed jawboning, trying to prevent interest rates from rising further."

Hurley said it is difficult to know if enough of a concession has been built into the market to help the auctions to get good bids. With the Fed's actions potentially supporting the market, the market's ability to create the concession that it wants is also in doubt.

"The Fed definitely doesn't want to see interest rates rise, and they're continuing their QE2 program, and it's very difficult to stand in front of the Fed and try to prevent them from doing what they want," she said.

Those opposing forces should make for another rocky week for agencies, Hurley said.

"I expect that volatility to continue," she said.

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