Agency spreads end flat, but yields drop on disappointing payrolls; coming supply in focus

By Kenneth Lim

Boston, Jan. 7 - Agency spreads closed mostly flat on Friday, although yields fell as the market turned slightly positive following a mixed non-farm payrolls report.

Bullet spreads ended unchanged on the day as investors seemed satisfied to just stay in line with Treasuries. The lack of movement was a little disappointing for traders, who had been hoping that Friday's labor situation report would spark some activity in a quiet week.

"Agency spreads didn't do a whole lot," an agency trader said. "We didn't see a ton of flows. I heard there was a ton of flows away, but I didn't see it. The Street was looking for a big pop to sell into Treasury supply next week, and investors were looking for a big pullback to buy. We got neither out of the gate, and that was kind of the anomaly of the day."

Callable spreads narrowed as volatility quieted down. Volatility tends to ease off after major events like Friday's payroll numbers and Federal Reserve chairman Ben Bernanke's testimony in Congress, the trader explained.

"Volatility will come off, which tightens callable spreads, although there's a bid for volatility out there that should keep kind of a lid on it," the trader said. "Everyone who was sitting on paper at a slight discount moved it back up to par."

Mixed messages confuse market

Investors on Friday tried to assess what appeared to be confusing economic news.

"It was kind of a strange day today," the trader said. "We spent the day trying to figure out if the numbers were strong or weak, and obviously the Street was trying to grapple with that too. I think it turned out to be a little weaker, and Bernanke was a little soft on his comments."

The Labor Department said non-farm payrolls rose by just 103,000 in December, far short of Street estimates, which had been raised midweek following a strong ADP Employer Services report on private employment.

But the unemployment rate also fell to 9.4% from 9.8%, which was better than expected, although the improvement could have been partly due to people stopping their job search.

Meanwhile, Bernanke told Congress that economic growth in 2011 is likely to be "moderately stronger" than in 2010.

"When the 103,000 hit as the headline print, that would dictate a sharp move upward in prices, but they also took a look at the unemployment rate and that dropped significantly...everybody was kind of scratching their heads," said the trader, who added that there was some short covering later in the day.

Supply ahead

The market is likely to be distracted by supply in the week ahead, the trader said.

In agencies, Fannie Mae has a calendar announcement on Benchmark Notes issuance on Jan. 12.

"I think the natural spot for them would be a new two- or three-year," the trader said. "I think there's room enough if they want to come with threes [after Freddie Mac sold three-years on Jan. 5.]"

The Treasury will also auction $66 billion of three-, 10- and 30-year debt over three days, which could affect how rates behave in the coming week.

The biggest supply distraction, however, will probably be corporate issuance, the trader said.

"We continue to be deluged with corporate supply, to the point where it was so quiet this week and we're trying to wonder where everyone was," the trader said. "I think they were so caught up with new corporate supply, we kind of got pushed aside. I think that will continue. As long as that corporate issuance market remains active and heavy, I expect we'll take a back seat."

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