Agencies widen on pessimism about employment data, flight to quality; callables active

By Kenneth Lim

Boston, Sept. 1 - Agency spreads widened Thursday as investors piled into Treasuries in anticipation of weak employment data before the long weekend.

Bullet spreads closed half to 1 basis point wider versus Treasuries across the yield curve and underperformed spreads by 1 bp to 2 bps.

"The market bounced back pretty good at the end of the day, and spreads for the most part outran agencies just a little bit," an agency trader said.

Trading volumes in bullets were muted, but callables had another busy session. Much of the activity in callables has come on the back of a wave of redemptions, with about $100 billion of notes believed to have been called in August because of the recent drop in yields and expectations of low rates going forward.

"A lot of money [is] out there looking for a home, and [with] the last day or two with the rally and tightening in callable spreads, new issue coupons were coming lower," the trader said.

Thursday's callable activity seemed to be focused on deals that priced earlier in the week, when coupons were slightly higher.

"There's a decent overhang of paper because of the deals printed over the last week, and in the last day or two those really started to clean up," the trader said.

Yields drop in anticipation

Yields fell Thursday despite a decent set of economic data, with the market preferring to take safer positions ahead of Friday's employment situation report.

The ISM Manufacturing index slipped to 50.6 in August from 50.9 in July but beat Street expectations for a weaker reading of 48.5.

The Labor Department also reported that new jobless claims slipped to 409,000 in the week ended Aug. 27. That was a slight improvement from the revised 421,000 number in the previous week but was higher than the consensus estimate of 407,000.

"In the ISM data I think some of the categories had a little bit of weakness," the trader said.

A lackluster session for equities also helped to push yields lower.

"At the end of the day, we're back to how stocks trade, and stocks kind of took a little nosedive toward the end of the day, and we've seen recently that whenever that happens people pile into Treasuries," the trader said.

The chief motivation for Thursday's market movement was probably anticipation of poor numbers on Friday, when the Labor Department releases non-farm payroll and unemployment rate data for August.

The market currently expects non-farm payrolls to increase by 50,000 to 75,000, which would be considered a very weak number, the trader said.

"The market could be set up for a pretty good downdraft if the numbers are better than expected," the trader said. "Given the magnitude of the buying [in Treasuries], unless you get an off-the-chart low number you're not going to see yields go much lower."

Holiday, supply muddy picture

Market action on Friday could be concentrated in the early part of the day following the release of the labor data, the trader said.

The long weekend - Monday is a long weekend for Labor Day in the United States - will probably lead to a quiet afternoon for the markets, while corporate supply in the coming week could set the tone for yields heading into the end of the week.

"If it comes at consensus, everyone checks the train schedule for the long weekend," the trader said. "If the corporate calendar is going to pick up, what happens is you could get some pre-deal hedging and the market sells off into the close if the market's real thin."

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