Agencies claw back, but still wider after volatile day; cautiousness dominates sentiment

By Kenneth Lim

Boston, May 21 - Agency spreads widened slightly on Friday after a volatile session that saw large swings in swaps.

Late narrowing helped bullet spreads to close about 1 basis point out on the day, with longer-dated paper outperforming slightly. The front end of the yield curve ended about 1 to 2 bps wider, while back-end spreads eased out by 0.5 bp.

"It was pretty panicky this morning," one trader said. "We had some big moves wider in swaps and agencies were kind of wider, but not as much as swaps, and swaps have come in quite a bit since then, so agencies basically followed."

Trading volumes were good, with some big trades moving through the session.

"It was pretty heavy," the trader said. "Saw some guys come in, made some big, chunky bids."

Callables had another slow session, with the market's richness putting a damper on the attractiveness of new deals.

It was "kind of slow today," the trader said. "The agents' funding levels are very high; in other words, it's very expensive to issue. Bullets are trading at very expensive levels versus swaps, which means funding levels are expensive for callables."

Confused markets

The agency market faces some confusion over the outlook for spreads and rates at the moment, given the uncertainty surrounding Europe's debt crisis and the health of the domestic economy.

"Definitely confusion," the trader said. "You really don't know. It's really tough to say. Some of these off-the-runs trade with very wide bid offers. And some people still want to buy agencies, but they don't like the rates in the marketplace. These are the things that are adding to confusion."

Investors could be headed for more volatility, the trader added.

"Do I expect more volatility?" the trader said. "I would say yes. I'm not sure I foresee what's going to end this in the short term. I think you need the whole European situation solved before that happens."

Cautious weekend

In the meantime, investors packed up for the weekend amid an environment of caution.

"Treasuries are substantially off their low yields," the trader said. "The S&P is up 16 points, so that helps."

Rates could bounce back up when the new week arrives, especially given that equity markets ended in positive territory on Friday.

"I think when Asia comes in on Monday morning, they're going to see that the world didn't end, so that's going to give them a bit of a pause," the trader said. "And if the world doesn't end, Treasuries have no business being here, and they'll go higher, but there are still a lot of issues."

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