Agencies tighten on quarter-end buying as calls raise money supply; volumes could decline

By Kenneth Lim

Boston, June 28 - Agency spreads tightened sharply on Monday on a flurry of buying as accounts tried to position themselves for the end of the quarter.

"We're being distorted right now by month-end and quarter-end," an agency trader said.

Bullet spreads closed about 2 basis points tighter across the yield curve, with the longer end doing better simply because there is more room to improve than at the front end, which is at historic tights.

"Agency spreads have done quite well," the trader said. "Swap spreads tightened for the most part. Since I walked in this morning, swaps are in 1 to 1.5 bps. Agencies have outperformed pretty much across the curve. There's been good buying in agencies."

Callable rush

Part of the frenzied bidding on Monday was fuelled by the large volume of paper getting called over the past two weeks, the trader explained.

"There have been $35 billion to $40 billion in callables called over the last 10 days or so," the trader said. "Investors are getting cash back when it's least desired to be getting cash back."

Investors are trying to put that cash into positions that can get as much yield as possible, while staying within their investment guidelines. That has generated buying in agencies, even though the market is relatively rich.

"You've kind of got to take a step back...because there's some accounts that do things because they have to, whether it's index extension or just tidying up the balance sheets," the trader said. "There's a lot of this at the end of each month and now with the quarter end it's even more."

The trader was therefore skeptical about Monday's tightening.

"I do think there could be a sort of relief rally at some point, to get us back a little toward higher yields, but the more cash that builds, the shallower the relief is going to be," the trader said.

Slow week ahead

Despite the month end-related bidding, the market may not move that much once the third quarter arrives, because the Independence Day holiday on July 5 will take a number of players out of the office.

"That distorts some flows," the trader said. "If you get any kind of a sell-off after Tuesday...and you get any kind of pullback, there's not going to be a lot of people in their offices to support that."

Spreads could also remain tight for the rest of the week because there is no scheduled benchmark-sized issuance on the primary calendar.

"The other factor that's kind of been working for spreads, but working against a back-up in rates, is there's not a lot of supply," the trader said. "Even a couple of billion from [Federal Farm Credit Banks] wouldn't help a lot. When Freddie Mac passed in their last round, on the 24th, the Street was really looking to that to fill some needs, and what used to be large and liquid issues are not being treated as such, so there isn't a willingness to short in a big way that we used to see."

Friday will nevertheless be worth watching with employment data coming out on the economic front. Investors will be looking to see how the job market is faring after weakness in May.

"You've got to pry out the private payroll data and look beyond the headline numbers," the trader said.

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