Agencies end tighter on paper-thin volumes, spotty window dressing; more volatility ahead

By Kenneth Lim

Boston, Dec. 21 - Agency spreads narrowed slightly on Tuesday in another quiet session as trading desks began to thin out ahead of the year-end holidays.

Bullet spreads ended a touch tighter on the day, but volumes were too low to read much into the day's moves.

"The agency market is shot, it's done for the year," said Mike Goldman, head of agency trading at Guggenheim Partners. "We're seeing some activity, but on very, very low volumes."

Callable issuance was also light, although slightly better than Monday, Goldman added.

Late bids

Agency investors mostly shrugged off news early in the day that Moody's Investors Service warned that it could downgrade Portugal's credit rating by two notches.

The news sent swaps slightly wider and gave Treasuries a morning rally, but agencies mostly kept pace with Treasuries.

"The news about Portugal wasn't really a big deal," an agency trader said. "I guess it put some pressure on swaps, but for the most part agencies were keeping in line with Treasuries."

The market continued to see some bids at the front end of the yield curve as some accounts sought to do some last-minute window dressing before the end of the year.

"It does give a little bit of support, but the volumes are so light this time of the year they don't really tell you anything," the trader said. "The vast, vast majority of the market already closed their books."

Volatile end to year

The market could continue to see high volatility for the rest of the year in terms of yields, the trader said. That is because low market volumes will tend to exaggerate moves in the markets, both in Treasuries and agencies.

The Treasury market is also operating under a cloud of uncertainty regarding the strength of the economy, the impact of the Federal Reserve's debt buybacks and the stability of sovereign credit in Europe.

But in terms of spreads, agencies should be stable versus Treasuries until after the new year.

"What usually happens is when there's nothing going on in agencies the market's just going to maintain the spread and follow the lead of the other market, whether it's swaps or Treasuries," the trader said. "Hopefully things will calm down enough after Jan. 1, and then we'll see how things go."

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