Agencies tighten as Treasury yields finally back up; bargain hunters exploit recent widening

By Kenneth Lim

Boston, June 2 - Agency spreads narrowed slightly Thursday amid some bargain hunting as Treasuries finally retreated ahead of Friday's key employment report.

Bullet spreads narrowed in the front end of the yield curve, but were flat in the three- to seven-year sector, an agency trader said. The long end of the curve also tightened a touch.

"As far as bullets go, there was really no direction, more kind of two-way flow," the trader said.

The callable market remained quiet as the market seemed to be willing to wait out Friday's numbers.

"I think more callables were printed yesterday," the trader said.

Trading volumes remained quiet, however, with the uncertainty surrounding the employment situation report keeping some money on the sidelines.

"I don't think volumes have been much different from the past few days," the trader said.

Bargain hunters make moves

The agency market finally saw an uptick in buying interest after spreads had been creeping wider over the past few weeks.

Agencies had been marching in lock-step with swaps for most of the past week as rallying Treasuries left most spread assets behind. But while swaps continued to widen on Thursday, agencies fared better.

"Today was the first day when swaps were out a ton and agencies didn't keep up," the trader said. "Today agencies held their own."

Yields rose on Thursday amid profit taking following the relentless rally in Treasury prices over the past month. The selling was given a further boost after Moody's Investors Service said it was placing the United States' credit rating on review for a possible downgrade on the risk that lawmakers will not be able to reach an agreement to raise the debt limit on time to avert a default.

"The heightened polarization over the debt limit has increased the odds of a short-lived default," Moody's said. "If this situation remains unchanged in coming weeks, Moody's will place the rating under review."

Some of the selling was also precipitated by rate investors shedding some of their exposure to Treasuries ahead of Friday's numbers in case the data is not as bad as expected.

"I think today for the first time a lot of it was just people taking stands, especially in outrights," the trader said.

Agencies benefited from bargain hunters who were looking to take advantage of the recent widening.

"Spreads were at wides that we haven't seen in a while," the trader said. "For example, the three-year Fannie Mae of June 2014, it's now offered through where they priced about one month ago, so people are now coming back."

Uncertain Friday

Investors by the afternoon were focused on Friday's non-farm payrolls and unemployment rate numbers to guide the market's next move.

But agencies will probably only see a strong pick-up in trading on Friday if the data significantly misses or surpasses Street estimates, the trader said.

The biggest impact will probably be on yield levels, rather than on spreads.

"If the number is way more or less, either way, people will be trading...[on rates] but not really on spreads," the trader said.

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