Agencies flat, keep pace with Treasury rally; market quiet to end positive week, month

By Kenneth Lim

Boston, July 30 - Agency spreads closed unchanged on Friday in a lackluster session amid confidence that the market was ending the week and the month on a positive note.

"Agencies didn't have much of a move today," said Ted Ake, managing director of U.S. Treasury and agency trading at Societe Generale. The move was "plus or minus half a basis point."

Trading volumes were low, he added.

Another trader said callable volumes were decent, but the market was not doing much on a summer Friday.

"Most of the attention today is on Treasuries and equities," the trader said. "Agencies are kind of on the backburner for now."

Meeting resistance

The markets saw some money shift toward safe havens on Friday after the U.S. Commerce Department showed that the country's gross domestic product rose slower in the second quarter of the year.

GDP gained 2.4% in the April to June period, less than the revised 3.7% in the first quarter and below the 2.5% Street prediction.

The trader said agencies mostly kept pace with Treasuries, although spreads found it difficult to tighten much more.

"I think we're seeing a little bit of resistance here because of the tight spreads and the low absolute yields," the trader said.

Investors were also content to close out their agency books better than at the start of the week and the month, the trader added.

"A lot of people have made their money already and they're happy to just cruise all the way until after the weekend," the trader said.

Strong week

The agency market consistently tightened over the past week, and spreads are narrower on the month, the trader said. Month-end buying helped to support the market during the week, while Freddie Mac's decision not to issue any Reference Notes kept supply at a trickle.

"It was a pretty good week for agencies," the trader said. "Or at least it was good for the short term. In the bigger scheme of things, we're suffering from some liquidity issues in agencies that I think isn't healthy for the market. Everyone wants to buy but nobody wants to sell."

Barclays Capital analysts Rajiv Setia and James Ma wrote in a note that "investors appear to be reaching for yield, just as the spigot of agency bellwether supply is turning off."

A tightening bias in swap spreads over the next few months should continue to favor callable supply over benchmark bullets, and the analysts recommend buying callables and step-ups during the drought.

"We believe these structures [step-ups] are particularly suitable for investors unwilling to bear as much prepayment/extension risk, while being comfortable with the distinction between a Fannie Mae/Freddie Mac name over the Ginnie Mae underlying the step-up callable MBS," the analysts wrote.

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