Agencies nudge tighter, yields rise on profit taking; investors eye supply, Fed meeting

By Kenneth Lim

Boston, Oct. 25 - Agency spreads tightened slightly on Monday, although yields were lower as investors took profit on some of the recent run-up in rates.

Bullet spreads narrowed by about 1 to 1.5 basis points across the yield curve, said Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial.

"Agencies were back in yield, probably 1 to 1.5 bps in in terms of spreads," he said. "We had a really strong run-up last week, so we're giving back a little bit of ground - nothing more than some profit-taking and repositioning."

Trading volumes were on the light side, although there was a good balance to flows.

The market saw "fairly decent flows," Riley said. "We saw some sellers in the five- to 10-year sectors and buyers in the two- to three-year sectors."

Primary action ahead

Investors are also setting up for a busy week of supply. Fannie Mae is scheduled to make a calendar announcement on Benchmark Notes on Wednesday, while the U.S. Treasury will sell two-, five- and seven-year notes Tuesday to Thursday.

"We do have some supply this week, so right here, right now, the market feels a little heavy," Riley said.

Monday's Treasury auction of five-year Treasury Inflation-Protected Securities sold extremely well, with the $10 billion offering going at a high yield of minus 0.55%, the first time TIPS have been sold at negative yield.

Signs are also positive for an offering by Fannie Mae, given that supply has been thin because the agencies have not needed so much funding this year.

All eyes on Fed

Investors could also be setting up for the Federal Reserve's meeting next week, with most market participants expecting the central bank to announce a new round of monetary stimulus through debt purchases.

"I would think that most people are going to be holders of bonds," Riley said. "Most people I speak to think that [quantitative easing 2] is a done deal. The only question is are they going to announce an exact amount...or just going to say, we're going to be buying back Treasury debt."

If the Fed begins to buy Treasuries from the market, that will push rates lower, but in the meantime there will be volatility in the markets. Investors will take profit quickly but will also be quick to buy on dips.

"We're seeing a fair amount of volatility now," Riley said.

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