Agency spreads narrow, volumes pick up as buyers return; callable step-up issuance grows

By Kenneth Lim

Boston, March 4 - Agency spreads tightened slightly on Thursday as the market continued to enjoy the return of buyers, while callable step-up issuance picked up.

Bullet spreads were a touch narrower across the yield curve, said Christopher White, senior vice president of fixed income sales and trading at Moors & Cabot Capital Markets. Freddie Mac's new 1.625% Reference Notes due April 2013 tightened by about 1 basis point to close at 29.75 bps on the offer side after being priced at 31.5 bps on Thursday.

"Spreads were a little better today," he said. "Swaps today are basically unchanged, so they've actually outperformed today."

Trading volumes were on the light to medium end of the spectrum, although activity was better on Thursday, White added.

"Secondary trading has been active," he said. "I think you've had a lot of real money buyers coming in."

Widening week

On the week, however, agency spreads are about 2 to 3 bps wider across the curve and have underperformed swaps.

Concerns that trading would slow down on Thursday ahead of Friday's non-farm payrolls numbers proved unfounded as "flows today were pretty good," White said. Investors may not be relying too much on the data because harsh winter storms in February and census-related hiring could distort the numbers, he explained.

"I think non-farm payrolls tomorrow is going to be a wait-and-see...I think people aren't really going to be acting on that information," White said.

Market participants are also dealing with changes related to the beginning of agency debt trading reporting on the Trade Reporting and Compliance Engine of the Financial Industry Regulatory Authority. White said the move is having a bigger impact on off-the-run issues, and he remained concerned about wider bid-ask spreads on those issues.

"If you're a dealer or a prop desk and you're asked to make a trade, somebody is going to know your cost, and you're going to want to be paid for it," he said.

Step-ups dominate issuance

Callable step-up issuance picked up on Thursday as investors tried to get better yields especially at the very front end of the curve, White said.

"Like today...40% of what I would consider the more retail type of issuance, 40% have a step option to it...normally it's around 10%," he said.

Money market investors can pick up about 15 bps at the front end by switching to step-up structures, he said. Investors who have agency debt that are rolling off within 18 months are also switching to products with step-up call structures that offer better returns.

"The bottom line is there are some extension trades out of the very short end," White said. "You're giving up some optionality because you're going into a call security, but with a one-time call it's less risky than a continuous call if rates go higher."

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