Agencies ease out on position squaring for year-end; market could see lower liquidity

By Kenneth Lim

Boston, Dec. 6 - Agency spreads widened slightly on some duration shedding Monday as some traders began to prepare for the year-end.

Bullet spreads closed about 1 basis point farther out from Treasuries for most of the yield curve, while the 30-year sector underperformed at about 2.5 bps wider.

"We did see agencies get pushed a little wider today, especially at the long end with swaps, and saw the agency curve try to steepen relative to the swap curve," an agency trader said.

Callable issuance was seen to be slightly slower on the day with Treasuries recovering slightly the previous week's decline.

"Today was a little slower," one market source said. "Issuance was pretty active last week on the back-up, but I guess rates went down a little today and it's a Monday. The market tends to be a little slower on Mondays."

Investors eye year-end

The overall agency market was "fairly quiet" on Monday, the trader said.

The agency curve underperformed Treasuries and swaps because there were some dealers who were beginning to square positions for the year-end, the trader said.

"A couple of guys were shedding duration a little bit here," the trader said.

The motivation for those traders is the expectation that volumes, especially in off-the-run paper, will dry up fairly quickly as the new year approaches. Concerned about a lack of liquidity, those dealers are making their year-end moves now, the trader said.

"There's some concern that liquidity will be a concern going into the year-end," the trader said. "We saw some active quoting in off-the-runs. It's mostly dealers, though. I don't think customers have been shedding as much."

Foreign banks slow down

Adding to the concerns of lower liquidity was the fact that Freddie Mac's $4 billion offering of new 0.625% two-year Reference Notes at the start of the month met with lackluster foreign demand, the trader said.

"It was a mostly domestic book last week with Freddie Mac, which means some central banks have slowed down a little," the trader said.

A trend could be established this week if Federal Home Loan Banks gets the same result on a front-end offering, the trader added.

FHLB will make an announcement on Global Notes issuance on Wednesday as part of its issuance calendar.

A front-end deal is expected, the trader said.

"We'd expect them to be somewhere at the front end," the trader said. "They haven't done a two-year since June, so I wouldn't mind seeing a two-year. Generally they're looking at not the tightest Libor level, but it's a good funding level for two-years."

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