Agencies widen as liquidity concerns spur broad sell-off; FHLB front-end announcement eyed

By Kenneth Lim

Boston, Dec. 7 - Agency spreads widened at the long end of the yield curve on Tuesday as a lack of liquidity amplified a broad bond sell-off.

Bullet spreads closed flat in the two- to three-year sectors but widened by 2 to 3 basis points in five-year and longer maturities. Yields rose across the board on sharp selling in Treasuries.

"It has been a very interesting day," an agency trader said. "Agency spreads did OK today, but you can tell it's getting less liquid out there. Any $10 million or more trade that comes on the screen, you can see the effect on the market."

Callable issuance was robust with the higher yields.

"The callable market continues to churn out sausage," the trader said. "The new issue coupons in the five-year sector got back toward 2.25%, and I saw a couple of secondary pieces at 2.35% trade."

But even the callable market remains slightly soft because the wild swings in rates recently have been catching investors off guard.

"We had a sharp widening in callable spreads as volatility spiked...then spreads tightened as volatility came off, and the guys who hedged at the wrong time were suddenly too long, so guys are really chasing the trade a little bit," the trader said.

Yields rise on concerns

Fixed income markets took a beating on Tuesday as the White House agreed to a two-year extension of tax cuts and a one-year extension of jobless benefits.

The tax deal will also cut Social Security taxes for a year.

The proposal is expected to add to the federal budget deficit over the next two years and stoke fears of inflation, sending rates higher.

Front-end spreads fared better on the day because of support from absolute rate buyers, who took Tuesday's back-up as an opportunity to pick up yield.

"You get a lot of rate buyers come in on backups like we saw today," the trader said.

Longer agency spreads were also affected by the poor liquidity in those sectors, exaggerating any selling activity.

"I think it's really a liquidity issue right now," the trader said. "The Street is still fundamentally long, but anytime somebody comes in to sell something on the longer part of the curve, it's going to have an effect."

Supply, volatility ahead

The market could see some supply in the next couple of days with Federal Home Loan Banks slated to make a calendar announcement Wednesday on the issuance of Global Notes.

The best sector for FHLB to issue, in terms of maturity, is a new two-year deal, but that would mean pricing at a concession of about Libor minus 7 or 8 bps, the trader said. For an agency that is "really driven by funding levels," this may be too rich.

"They've done a lot of activity in the TAP market...which lessens the need for them to do a new Global issue," the trader said.

If FHLB does not issue a new two-year note, it might choose to reopen a three-year series, the trader added.

Beyond the supply, Treasury auctions over the next two days could keep volatility elevated.

Tuesday's announcement about the tax deal also did not mention extending the Build America Bonds program, which could lead to spillover effects if local governments rush to issue debt to take advantage of the program, which expires at the end of the year.

"Until they tie up all the loose strings on this tax package I think we're going to be headed for some volatility," the trader said.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.