Agencies flat as Treasuries drop; payrolls loom; economic data, Europe news up volatility

By Kenneth Lim

Boston, Dec. 2 - Agency spreads were unchanged on Thursday to stick with falling Treasuries as strong economic data trimmed appetites for fixed income ahead of a key payroll report.

Bullet spreads closed flat at the front end of the yield curve and widened slightly for longer paper, said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson & Co.

"They're backing up with Treasuries," she said. "Spreads are unchanged to a tad wider, so they're increasing in yield well."

The callable segment saw decent volumes on the back-up in interest rates, which allows investors to buy callables with higher coupons.

"There's still a fair amount of interest in callables just because you can pick up more than what you can on agency bullets," Hurley said, "and definitely a lot of interest in step-up bonds because of their defensive nature."

Widespread concern

Agencies were not able to take advantage of the Treasury decline on Thursday because both asset classes are exposed to the same kinds of concerns.

"There's definitely a concern in the Street," Hurley said. "A lot of the economic data has been coming a little bit stronger than expected, which is raising concern that rates have indeed bottomed out and could be poised for an uptrend, and we are significantly higher than the low levels that we have seen about a month ago."

The National Association of Realtors on Thursday said pending home sales rose 10.4%, surpassing Street expectations for a drop. U.S. retailers also reported a better-than-expected 6% increase in same-store sales.

Those positive economic reports offset a surprising increase in jobless claims, which rose 26,000 in the latest week.

"Net-net, I'd say the economic data this week has been stronger than expected," an agency trader said. "That's putting pressure on the bond markets ahead of tomorrow's payrolls."

Volatile period ahead

Investors remain uncertain about the direction of the U.S. economy, and Fridays' numbers could provide a clue, the trader said.

"It's easily one of the most important pieces of data since the Fed began [quantitative easing]," the trader said. "A lot of people will be trying to figure out how they're going to end the year."

The choppiness caused by the domestic economy will be complicated by crosswinds coming from Europe, the trader added.

"You have two different forces meeting in the market, and that's going to give you a lot of volatility for the rest of the year," the trader said.

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