Agencies end flat as market eyes higher rates, possible government shutdown; supply ahead

By Kenneth Lim

Boston, April 8 - Agency spreads remained stuck at current tights on Friday amid low volumes and expectations of higher interest rates.

Bullet spreads closed the day unchanged with little in the way of market-moving news.

"Spreads are better bid, but we're going out on the day basically unchanged," an agency trader said. "It was an underwhelming day from a volume standpoint."

Trading volumes were light amid a lack of major headlines and with the weekend looming.

"People aren't really paying attention to the agency market this afternoon," the trader said.

Callable issuance was decent but mostly in smaller deals that are typically targeted at retail segments.

There were "a lot of retail type $15 million to $100 million type deals," the trader said.

Callable activity usually quiets down when yields fall because investors want better-looking coupons on products, the trader said. On the other hand, when rates rise, callable issuance tends to pick up as investors try to capture the higher coupons.

But callable activity has been slow to pick up among larger accounts over the past week when Treasury yields have backed up.

"I think the mentality out there is we could possibly move to higher rates, so there's a little bit of patience being exhibited now," the trader said.

Lingering demand

The prospect of higher rates has led to some money going out of fixed income markets, which has affected agencies as well, the trader said.

"I think there's just been some larger asset allocation trades out of fixed income in general," the trader said. "People [are] kind of looking at rates here and thinking the Fed's closer to raising rates than not, and people [are] starting to feel like they missed the equity move."

But the trader sees signs of demand lingering under the surface.

"We've kind of ground in to tight levels versus Treasuries," the trader said. "Two-year securities are plus 5 bps versus matching maturities, so how much tighter can they go? But at the same time each time we widen out there's accounts ready to buy."

"Everything just seems to be in a holding pattern," the trader added.

Supply ahead

The market will focus on supply when it returns after the weekend. In addition to the Treasury's $66 billion of auctions in the three-, 10- and 30-year sectors, Federal Home Loan Banks is also scheduled to make a calendar announcement on Wednesday.

Funding levels have firmed, so conditions are attractive for the issuer to print new paper, the trader said.

"It's going to come down to what their needs are," the trader said. "A new three-year would be a good fit for them. However, funding levels favor a new two-year, so if they don't do that they could reopen twos."

The trader discounted the effect of the federal government's possible shutdown as Congress struggles to come to an agreement on the budget.

"For the most part it won't be a huge market-moving event," the trader said. "Some people say it could put a dampener on the economy, but I do believe there'll be enough pressure on them to get something done."

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