Agency spreads widen as strong payrolls elude hopeful investors; week's tightening erased

By Kenneth Lim

Boston, June 4 - Agency spreads widened on Friday as investors moved back into safe-haven Treasuries following disappointing payroll numbers.

Bullet spreads closed about 1 to 2 basis points wider in the two-year sector, while 10-year spreads added about 1.5 bps. Five-year spreads were hit the hardest, expanding by 2 to 3 bps. Compared to swaps, agencies actually outperformed slightly.

"I think the underlying theme is the market had built itself up for a huge number this morning and when it came in less than expected, we were off to the races," an agency trader said.

Callable issuance was slow on lower volatility and the flight to quality on Friday.

"For the most part the only activity of note this week was...a couple of auction pieces," the trader said. "Since Libor backed up the way it did...it's tightened spreads versus bullets, so for the most part there's a lot more value in the secondary market, not so much in new issues."

Trading volumes in general were slow on Friday, the trader added.

"It was pretty quiet," the trader said.

Payroll disappointment

Underlining Friday's widening was the government's payroll report, which came in less than the market was expecting.

The Labor Department said 431,000 jobs were created in May, although most of those jobs were related to hiring for the 2010 Census. The market consensus expectation was for about 500,000 new jobs. Private payrolls, which many on the Street considered a more important figure, fell to 41,000 in May from 218,000 in April.

"For the first time in a long time, nobody was paying attention to the headline numbers," the trader said. "They were looking at private rather than total payrolls, and the pullback from last month's strong private numbers, even adjusted for seasonality, I think people were disappointed."

The trader said expectations had been extremely high, so the drop in the market's mood was correspondingly sharp.

"I heard people whispering double dip and deflation over the last couple of hours here, but for a lack of anything else to drive us," the trader said.

Flat week

The spread expansion on Friday erased tightening over the previous couple of days and left the agency market unchanged on the week versus Treasuries.

The five-year sector, which had outperformed the week before, ended the week slightly wider. The front end of the yield curve also lagged swaps a little, "primarily because we had supply," the trader said.

"We've had $11 billion in supply over the last two weeks from Fannie Mae and Freddie Mac, which has softened the sector up a bit," the trader said.

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