Agencies widen on profit-taking, renewed safe-haven bids ahead of weekend; supply eyed

By Kenneth Lim

Boston, Aug. 12 - Agency spreads eased out slightly Friday on slight profit-taking as yields resumed their downward march heading into the weekend.

Bullet spreads closed about half to 1 basis point wider versus Treasuries on the day.

"Spreads today were just a little wider, a touch softer for the first time in a while," one agency trader said.

The callable market was also quieter than earlier in the week, although there was still a decent amount of flows.

"Callables continue to be active, although I would say anytime there's a huge rally in the market it usually takes callables a few days to catch up because people are shocked at the coupons," the trader said.

The callable segment will probably pick up in the coming week, the trader added.

"Callables have lagged a little bit in this move," the trader said. "But [government-sponsored enterprises] funding needs are still fairly high, and in terms of underwriting they don't have as much as they probably need. So I think callable activity will probably pick up next week."

Yields fall again

One day after climbing sharply, yields fell again on Friday as investors shored up on safe-haven assets before the weekend.

Agencies struggled to catch up, although bullet spreads were easing off of recent tights after narrowing for most of the week.

"We saw some profit-taking in agencies," the trader said. "We tightened very quickly and very fast [earlier] and I think we saw guys kind of hit the bid a little bit. But the bid in the marketplace still remains pretty good."

But one agency source said Friday's market was "really sloppy" with too little liquidity to read too much into the day's actions.

"The market's very thin," the source said. "One bid gets hit, all the other bids disappear. One offer gets hit, all the other offers go off. There's a lot of dealer-driven positioning today."

Supply in focus

Agency investors are focused on supply in the coming week, with Fannie Mae on the issuance calendar to make an announcement on Benchmark Notes on Tuesday.

On Thursday, the Treasury Department will offer $12 billion of five-year Treasury Inflation-Protected Securities.

"I think going forward it's going to be supply driven," the source said.

Both the trader and the source expected agency spreads to remain tight.

"I don't see us widening, short of a sharp steepening in the Treasury curve," the source said.

The trader felt that the latest assurance from the Federal Reserve that short-term interest rates will remain exceptionally low until mid-2013 should be supportive of demand for agencies.

"I definitely see them grinding tighter versus Treasuries," the trader said. "Anytime we're in a low yield environment like this, spread products usually do well. When the Fed tells you they're holding rates for two years, that's generally good for spread products. I think in a couple months we'll be tighter."

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