Agencies stay put as Treasuries rally on Libya unrest; market eyes busy week for supply

By Kenneth Lim

Boston, Feb. 22 - Agency spreads held firm on Tuesday in the face of falling Treasury yields, although volumes suffered from a lack of strong interest in the market.

Bullet spreads closed mostly unchanged, said Michael Skinner, an agency trader at Wall Street Access.

"Agencies didn't really do anything," he said, noting agencies were "kind of stuck in the mud for the day."

Callables saw a bit of interest because Tuesday's drop in Treasury yields made some of the older secondary paper - with their higher coupons - appear relatively more attractive.

"Some callables traded only because the rally in Treasuries made some stuff look pretty good," Skinner said.

Treasuries climb

Treasury prices rose on Tuesday as growing unrest in Libya sparked flight-to-quality bids for U.S. government-backed assets.

"Everyone's attention was on the unrest in Africa and the Middle East," Skinner said. "Treasuries reacted accordingly, rallying somewhat furiously, more in the long end and the belly."

Equity markets were likewise hammered by the brewing problems in the region.

"For once equities bit the bulls a little bit," Skinner said.

The sharp movements in Treasuries and equities formed a formidable distraction that mostly kept investors away from agencies.

"Volumes were below normal," Skinner said.

The sole consolation for agencies was that spreads held their ground even as Treasury yields slid lower, he said.

"Typically when Treasuries rally, agencies will widen a touch," Skinner said. "So I guess the fact that benchmarks didn't give up anything bodes well for the market. It's not a lot of volume, but that's kind of what we have to go with right now."

Supply ahead

The unrest in the Middle East will probably continue to be a major market driver for the rest of the week, Skinner said.

"Certainly the unrest over there has everyone's eyes," he said. "We'll probably trade off that."

The market will also see quite a bit of supply, both from the Treasury's upcoming five- and seven-year auctions as well as a Reference Notes issuance announcement on Thursday by Freddie Mac. With spreads now compressed and volumes languishing, supply has been the main source of trading activity for the market, Skinner said.

Callable issuance could also pick up if rates go back up.

"We're back to the 3.60%, 3.40% [10-year Treasury yield] kind of trade for now, so if the market dips, I think you'll see guys try to print some callables," Skinner said.

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