Agencies widen on high-grade corporate supply, Treasury rally takes toll; volatility eyed

By Kenneth Lim

Boston, Dec. 13 - Agency spreads closed flat to slightly wider on Monday amid a glut of investment-grade corporate supply and a rally in Treasuries.

Bullets spreads ended the day only about 0.5 to 1 basis point wider versus Treasuries, although yields declined following Friday's broad sell-off. Trading volumes were lackluster, reflecting a typical year-end slowdown.

"We closed better than Friday, although that's not hard to do," said Craig Ziegler, an agency trader at Gleacher & Co. "[There was] a little bit better tone than Friday, but activity is still pretty down. The Treasury market's signs are causing a little more dislocation at the forefront of people's minds, and they're looking at Treasuries instead."

Callable issuance was slow with Monday's higher rates.

There was not much issuance in callables, Ziegler said, noting a couple of reopenings of Federal Home Loan Banks TAP issues and Federal Farm Credit Banks issues on Monday.

Corporates add pressure

The agency market took a back seat to other fixed income assets on Monday amid wide intra-day moves by Treasuries and strong corporate supply.

"As the Treasury market rallied, some stuff traded better, but we didn't see a big move in spreads," Ziegler said.

Treasuries slipped early Monday before coming back in the afternoon, and that volatility left agencies playing catch up, another trader said.

"Agencies are just reacting to what's going on everywhere else," the trader said. "There's very little activity in agencies, hard to get things done in this market. Agencies are kind of a step behind Treasuries right now with Treasuries just going all over the place."

High issuance volumes in investment-grade corporates also put some pressure on agency spreads, the trader added. The unwinding of Treasury hedges as the corporate deals come to market is giving Treasuries a boost over agencies. At the same time, yield-seeking investors are also enticed by the new corporate issues to move further out on the risk curve beyond agencies.

All eyes on Treasuries

The week ahead could see continued volatility for the market as trading volumes decline and uncertainties about the Treasury market persist, the trader said.

"Treasuries are still the main attraction," the trader said. "Everything's going to depend on what Treasuries do this week."

Freddie Mac could add some supply later with a calendar announcement on Reference Notes issuance on Wednesday.

"I haven't heard anything yet," the trader said. "I would expect a two- or three-year, if they do anything at all, but I think there's as good of a chance that they're going to pass and wait until next year."

Tuesday's Federal Open Market Committee meeting is not expected yield much in the way of surprises.

"They'll probably stick to the same message of low yields and say they're going to continue [quantitative easing]," the trader said. "There's a risk that there could be some dissent about QE2, but I think it's unlikely."

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