Agencies narrow on weak payrolls, increased hopes of Fed purchases; richness might persist

By Kenneth Lim

Boston, Oct. 8 - Agency spreads tightened further Friday as disappointing payroll data raised hopes of market stimulus by the Federal Reserve.

Bullet spreads narrowed by about 2 to 4 basis points versus Treasuries by mid-afternoon on Friday.

"Agencies are performing extremely well, especially with the Treasury market up so much and you're performing better."

Trading volumes, however, were extremely light with a three-day weekend looming. The markets are closed Monday to observe Columbus Day.

"Honestly it's been a slow day," the trader said. "We've had the employment numbers in the morning, but after lunch a lot of people are already thinking about the weekend."

Callable issuance was also slow, although callable spreads tightened.

"Callables are performing well; with swaps and volatility and gamma moving lower, spreads have tightened," the trader said.

Data fuels QE talk

The U.S. Labor Department on Friday said non-farm payrolls declined by 95,000 in September, although private payrolls increased by 64,000.

The Street had been more optimistic, expecting a drop in total payrolls of just 8,000 and a private payrolls increase of 85,000.

The disappointing jobs data strengthened investors' belief that the Fed will announce a new round of asset purchases after its November meeting. The Fed's initial round of quantitative easing, which took place throughout 2009, targeted Treasuries, agency debt and agency mortgage-backed securities. A new round of actions could aim at those assets as well.

"I do think they'll be buying up agencies and maybe mortgage-backed securities," the trader said. "That's one of the reasons spreads are so tight right now."

Agencies are already historically rich after the first round of buying by the Fed took out a significant chunk of the existing supply, but investors will probably continue to seek out the asset class, the investor said.

"We don't have a lot of money domestically in the U.S. that has been reallocated into the stock market," the trader said. "Banks are reluctant to lend out money, so they're sitting on cash and they're buying agencies and Treasuries with that cash instead of lending it out.

"It's the same thing with corporate. They have a lot of cash, but they're not spending because of uncertainty in regulations, and they're buying Treasuries and agencies as well.

"You have this dynamic where people are putting money to work in Treasuries and agencies just because of the stability."

More tightening ahead

Spreads could continue to narrow after the weekend, or at least stay in place, the trader said.

Investors are unlikely to be fazed by the tight spreads because additional quantitative easing will affect all spread products, the trader added.

"Everything's relative, right?" the trader said. "If all other products are driving tighter, it's all going to be relative. If you can buy agencies at 10 over Treasuries, it's still a spread."

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