Agencies close flat as investors search for direction in quiet session; volatility eyed

By Kenneth Lim

Boston, June 25 - Agency spreads closed unchanged on the day as the market struggled to find a clear direction ahead of the weekend.

Treasury prices rose early in the day as the U.S. government cut its measure of the first-quarter growth in gross domestic product to 2.7% from the previous estimate of 3%. That rally in Treasuries pushed agency spreads wider initially, although the market managed to claw its way back later in the day.

"I think we came in today and Treasury markets were a little higher, so spreads were under some pressure," an agency trader said. "At one point we were maybe 1 basis point wider across the curve, but the market kind of found its legs. Let's call it unchanged on the day. Swaps spreads more or less came in from the wides."

Trading activity was at a crawl in an already slow week as the summer Friday kept volumes low.

"Today was one of the quieter days of the week," the trader said.

The one segment of the market that was still striding along was in callables, where step-up structures continue to face strong demand.

"We continue to see robust activity in callables," the trader said. "People keep getting called out of bonds, so with a steep yield curve, that's just going to continue to happen."

Confused outlook

Friday's up-and-down session reflected the market's uncertainty about where prices and spreads were heading, another agency trader said.

The GDP revision was not a big surprise for investors, who have already priced in concerns that the economic recovery may be experiencing some bumps, but it still set a negative tone ahead of the weekend, the second trader said.

There was also some early uncertainty about the impact of new financial regulations that were set overnight.

"I think the market took a little while to digest the new bill," the trader said. "There was a bit of relief buying near the end I think when guys realized that the new rules weren't as bad as they thought.

"Personally I think it's not all bad, and we all knew they were going to tighten the rules at some point after what happened in 2008. At least now we know what the new rules are going to be, instead of having to speculate."

News that legislators had scrapped a controversial proposal to have the banks pay the costs if Fannie Mae and Freddie Mac are liquidated was also warmly received by investors.

"That was just a stupid idea to begin with," the trader said. "If you take the government out of the equation of Fannie Mae and Freddie Mac you lose all basis for the two GSEs. The government can't sidestep this responsibility."

More volatility ahead

The trader said the week ahead could see more volatility in the market even as accounts try to set up for the quarter- and month-end.

"There's a strong desire in the market to go for safe-haven investments right now, but at the same time your safe-haven investments have gotten so rich over the past week, a lot of people are asking, do I really want to hold that and risk a last-minute correction that's going to affect my quarter-end?" the trader said.

The lack of benchmark supply in the coming week could also keep volumes low.

"If there's no supply, there's very little interest in agency bullets," the trader said, "especially in the summer. At least we have the World Cup to entertain us, right?"

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