Agency spreads widen on profit taking; Fed to buy at front end; market waiting to buy: trader

By Kenneth Lim

Boston, Jan. 21 - Agency spreads plodded outwards again on Thursday as high prices continued to spur profit taking by investors.

The shorter end of the yield curve held up slightly better on a purchase announcement by the Federal Reserve Bank of New York, which will buy agency notes on Friday.

Bullet spreads widened by about 1 basis point at the long end of the curve on Thursday, and by just a tad at the front end, said Mary Ann Hurley, vice president of fixed-income trading at D.A. Davidson & Co.

"It was kind of quiet," she said.

Another trader said the light volumes were partly due to a lack of buyers at current valuations.

"The market's just gotten extremely rich beginning in the last week of 2009," the trader said. "Right now we're seeing a bit of a push back, which I think actually is healthy for the market."

Corrective week

Spreads have been softening during the past week as profit takers dominated trading activity.

"We've been seeing a very gradual widening of spreads," Hurley said.

Investors are not necessarily concerned about the weakening spreads, she added.

"It's just with the rally of the Treasury market things have gotten very expensive and I think it needed to widen out just to attract the investors," Hurley said. "They're wanting wider spreads for purchases."

Agency spreads could yet tighten again once the market has softened enough, she said.

Fed targets front end

The Fed announced that it will buy agency notes due February 2012 to January 2014 on Friday as part of its outright purchase program.

The announcement was not a surprise for the market, which has become accustomed to an operation by the Fed every week.

"I think this was pretty much as expected," Hurley said.

The central bank has already bought about $162 billion of agency notes under the $175 billion program, which will end on March 31.

"Their agency purchase program is expected to end at the end of March unless they officially announce an extension," Hurley said.

Hurley said the Fed could still extend the purchasing program because of concerns about the market's ability to stand on its own.

"I frankly think that they've got to just to support housing because their purchases are the major thing that have kept spreads narrow, which is what has made mortgages affordable," she said. "But the end of March is still 2.5 months away; I'm not sure what's going to happen."

But the other agency trader did not think that an extension would be announced.

"I think their impact on the market at this stage is already minimal," the trader said. "They're not really buying up that much any more.

"The market's moved beyond the buybacks. I wouldn't be too worried about spreads widening too much once the Fed stops the buybacks because you've got the Treasury backing the market now. Even if there's a bit of widening, I think that could be helpful in terms of improving liquidity."

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