Agency spreads flat but outperform swaps as rate buyers swoop in; shorts could give lift

By Kenneth Lim

Boston, Dec. 23 - Agency spreads were unchanged to slightly wider on Wednesday but outperformed swaps as investors sought bargains on the recent rates selloff.

"I think the theme right now is kind of just wrapping up," an agency trader said. "But we're seeing good rate buying on the backup."

Absolute yields have also been increasing during the week because of a selloff in Treasuries, the trader said. But versus swaps, agencies have actually outperformed.

"Agency spreads have for the most part performed pretty well against swaps," the trader said. "We were essentially unchanged on the day, but for the week we're a couple of points tighter against swaps."

Trading volumes continued to be extremely light with many investors and traders already gone for the holidays. There is also no major supply until the end of the year, which may help to explain the relative strength of the agency markets at this time.

"The move tighter against swaps and Treasuries is partly due to...a lack of liquidity," the trader said. "It happens at this time every year. So I'd take it with a grain of salt."

Rate buyers make moves

Spreads have held better because rate buyers, who are going after the yields rather than spreads, are making their moves amid the weakness in rates.

"Yield-wise everything's higher, and that's where the rate buyers come in," the trader said. "Spread buyers came in the last couple of weeks to buy agencies versus Treasuries; now it's the rate investors who are buying agencies for the yields."

Treasuries saw a selloff on Wednesday as investors looked ahead to $118 billion of Treasury auctions in the last week of the year. The U.S. government will auction $44 billion of two-year Treasuries, $42 billion of five-year Treasuries and $32 billion of seven-year Treasuries when the market returns from Christmas.

Cantor Fitzgerald's head of rates strategy, George Goncalves, thought that Treasury investors could grab some easy yield from the auctions.

"In other spheres year-end sales usually take place post-holidays but that is not the case for Treasuries this time," he wrote in a note. "We believe the cheapening that we have seen of late in USTs [and mortgage-backed securities] offers value as a short-term trade and that the auctions at higher yields provide for a last minute gift of yield before the close of the year."

Possible boost ahead

The market closes early on Thursday, and trading activity could slow down even more, the trader said.

"I think everyone's going to come in and watch the clock," the trader said.

But agency prices could actually see a bit of an uptick on last-minute short covering.

"I wouldn't be surprised to see us head into the long weekend a little bit higher in price," the trader said. "It seems like it's been a one-way trade all week, and if there's any shorts out there they'd probably want to cover before the market shuts down."

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