Agencies close unchanged as mortgage hedging keeps spreads in line with falling Treasuries

By Kenneth Lim

Boston, Sept. 10 - Agency spreads closed flat on Friday as the market saw a glimpse of buying on the recent back-up in rates.

"Spreads held in quite nicely," an agency trader said. "I haven't seen much widening all day."

Trading volumes improved from the past several sessions, which had been quieted by the holidays.

"It's been a fairly busy day for us," the trader said.

Freddie Mac's newly issued 1.75% five-year Reference Notes continued to see good demand and tightened to a spread of about 28.5 basis points bid, 28 bps offered at the close.

The $5 billion deal priced Thursday at a spread of 29.5 bps over Treasuries, in line with price talk.

"The five-years are doing very, very well," the trader said. "The deal went real well. They sold $5 billion, and orders were almost $8 billion."

Back-up buying

Buyers came back to the market on Friday, seeing opportunities as Treasuries continued to drop and overall rates increased.

"With the market pulling back this morning, we tested levels at 2.82%, 2.83% on [10-year Treasuries], so that definitely brought in some buyers," the trader said.

Most of the activity was centered on new issues, as investors tried to get better coupons.

Agency spreads typically widen if Treasury yields fall, and narrow if Treasury yields increase, but that has not happened much over the past week. Rather, spreads have kept pace with Treasuries when government bond yields fall, while widening on sell-offs in Treasuries.

Mortgage hedgers are mostly behind the anomaly, the trader said.

"Some mortgage hedgers come in and hedge duration risk," the trader said. "As they come in, it's widening spreads as rates are going up. Normally when you have a more normalized market, you have two-way flow, and traditionally you used to see a tightening of spreads. But now with mortgage hedging, they're all moving in the same direction, they're all receiving, so that's been widening spreads."

Rates-driven market ahead

The market could see more activity after the weekend when investors return from Labor Day and Rosh Hashana holidays, the trader said.

But a lot of the outlook will depend on where rates are headed.

"I think everything's going to be directional," the trader said. "I think if rates continue to rise, we'll have customers maybe slow down a little bit until they think rates have bottomed out. But if rates come back down, I think you'll see a lot more activity in agencies."

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