Agency spreads narrow as supply awaits; thin volumes hinder accurate picture of market

By Kenneth Lim

Boston, July 26 - Agency spreads tightened a touch on an extremely quiet session Monday as investors mostly twiddled their thumbs ahead of a busy week for supply.

Bullet spreads closed the day about 0.5 to 2 basis points tighter versus Treasuries across the yield curve, traders said.

Callable issuance was thin, and any trading in the secondary market mostly focused on step-up structures, said Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial.

"Anything that's trading seems to be step-up bonds, given the layer of protection that they offer in case rates do back up," he said.

Another agency trader said the long end of the yield curve seemed to do slightly better, but only because there was more room for tightening in those sectors.

"Tens and 30s were in about 1.5 to 2 bps," the trader said. "I don't think there's any special reason that they're doing better today; it's just because there's not as much room in shorter maturities because they're already very tight."

The agency market mostly took its cue from Treasuries and swaps, the trader said.

"Treasuries were down a little today, which is the real reason agencies were tighter today," the trader said.

Weak volumes

Riley cautioned against relying too much on Monday's end-of-day levels because volumes were so low.

"We're not seeing anything trading today," he said, adding that he had let a few traders get off work early because of the slow market. "You can't get any real peg on the market from today's action."

Trading volumes on summer Mondays and Fridays tend to be below average, but this particular Monday was "probably the lowest volume day we've seen in a month," Riley added.

The trading malaise, however, was not reflective of current demand for agency debt, he said.

"Clearly there are buyers of U.S. dollar-denominated paper," Riley said. "Demand for Treasuries and agencies continues to be very strong."

Supply ahead

Investors are looking ahead to a potentially busy week for supply, the other trader said.

Freddie Mac has a calendar announcement on Reference Notes issuance on Thursday, and the market is not hopeful for a large deal to soothe its supply shortage.

"Honestly, everyone's hoping for a benchmark offering [of at least $3 billion], but I think most people expect them to come with a small reopening," the trader said. "They could potentially offer more just to take advantage of the favorable funding levels right now, but right now it seems their decisions are mainly guided by their funding needs, which are not very high."

The U.S. Treasury will also auction $104 billion of two-, five- and seven-year notes during the week. A rebound in absolute yields could bring buyers back to the richly valued markets, the trader said.

"If we can get a good back-up in rates, that might be enough to bring some of the buyers back from the sidelines," the trader said. "A lot of investors seem to be waiting for a back-up before they open their wallets again."

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