Agency spreads mixed as long end outperforms; trading volumes struggle amid rich valuations

By Kenneth Lim

Boston, Jan. 27 - Agency spreads ended an uneven session on Wednesday as uncertainties about the economic and regulatory environments added to a lack of direction.

Bullet spreads were wider by 1 to 2 basis points at the front end of the yield curve, said Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial. Five-year spreads ended unchanged, while 10-year to 30-year spreads came in by about 1 bp.

"Spreads are kind of mixed right now," Riley said.

Investors were also not paying as much attention as usual to Freddie Mac's Reference Notes issuance announcement for Thursday, Riley noted.

"There hasn't been a lot of talk about it," he said. "Most of the talk was on the Fed meeting and the State of the Union tonight."

Riley expects Freddie Mac to bring a deal in the front end.

"I think that would make the most sense," he said, noting the issue would be "probably three years and in. Time will tell. I would think if it is three years, it would be maybe in the low 20s [spread]."

Sideline sitting

Trading volumes continued to be weak on Wednesday as investors deal with uncertainties on the political and regulatory fronts.

"There's not a tremendous amount of activity today," Riley said. "It's been deadly quiet [with] halfway-decent flows."

The market was initially buoyed by what appeared to be a strong auction of five-year Treasuries, he said. But Treasuries weakened later in the day, with the new five-year Treasuries closing at a yield of 2.43%, about 6 bps higher than the 2.37% yield at pricing.

"There was good flow early in the day, especially after spreads were off yesterday by 1 to 2 bps across the curve," Riley said. "But when the Treasury market started to give up, the flow came to a screeching halt."

FOMC meeting raises concerns

The Federal Open Market Committee also concluded its January meeting on Wednesday.

The Fed's statement raised some eyebrows for disagreement within its ranks on interest rate policy, although the central bank reaffirmed its commitment to its current target. Thomas M. Hoenig, who heads the Federal Reserve Bank of Kansas, voted against the policy action because he thought that "economic and financial conditions had changed sufficiently" to warrant higher rates.

The Fed also cast a slightly more optimistic outlook on the U.S. economy, saying that "economic activity has continued to strengthen and that the deterioration in the labor market is abating." Specific to agencies, the Fed kept unchanged its $175 billion agency notes purchase program, which will end by March 31.

"For the first time, it wasn't a unanimous vote," Riley said. "I guess some people are taking it as the beginning of the tide turning."

Investors on Wednesday were also waiting out the president's State of the Union address in the evening.

"Sometimes we think our clients are on strike," Riley said. "I think it's the combination of low absolute yields and some political uncertainties that's driven people to the sidelines. We sit and wait for the next event and see if we can get something going."

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