Agencies widen as wary investors eye choppy Treasury market; volumes dry up with year-end

By Kenneth Lim

Boston, Dec. 16 - Agency spreads widened again on Thursday, lagging a volatile Treasury market, as wary investors refrained from bidding.

Bullet spreads closed about 1 basis point wider from Treasuries, although agency benchmarks kept pace with swaps, which also widened versus government debt.

"The market was higher overnight in Treasuries, so we came in the morning and right from the get go there was pain in the swap market," an agency trader said. "We would have been about 2 bps wider around lunchtime, but then Treasuries started to grind higher...and swaps tightened, pulling agencies in."

Callable issuance remained slow, and secondary callable trading was spotty with the year-end approaching.

"Guys don't have any balance sheet, and people are reluctant to bid," the trader said.

Light volumes

Trading activity was extremely quiet on Thursday, with the typical year-end slowdown keeping volumes at a low.

"It's been an interesting week, but agencies were relatively quiet," the trader said. "You spent 99.9% of your time just looking at duration, and that's for 99.9% of the people in the market, whether it's mortgages or agencies or swaps."

Whatever activity could be found was mostly focused on more liquid, on-the-run issues.

"The more esoteric, [medium-term notes], off-the-run stuff has completely dried up," the trader said. "Most of the trading is in five-years and in and relatively liquid stuff."

Very short-term paper also attracted some interest on the occasional drop in price.

"The market is very dollar price sensitive right now," the trader said. "There's not much interest in stuff that's above par, but there's some interest if it's below par."

The primary bullet market is also seen to be done for the year after Freddie Mac passed on a calendar opening Wednesday. Fannie Mae is next on the calendar, with an announcement on Benchmark Notes set for Dec. 20.

"Fannie Mae [is] on Monday, but just based on what they're doing, I don't think they'll issue anything," the trader said.

Current demand is also mostly from domestic investors, with foreign investors cautious about investing amid the current market volatility.

"Maybe next week we'll see some stuff, but people are in year-end mode and not looking to do a lot," the trader said.

Still some value

For investors looking to trade, there are still segments of the market that offer some value, the trader said.

Longer-term agency bullets of eight-year and longer maturities look cheap at the moment, the trader said.

"There's compelling value there, especially if you can find stuff below par," the trader said.

Longer callables are also cheaper now that rates have gone up. Five-year notes that are non-callable for one year and seven-year notes that are non-callable for two years look reasonably priced right now, although the short-term trade that was popular for most of the year is not as viable now.

"The three-month lock game is over; the six-month lock game is over," the trader said. "Now...you're looking at more bullet-like callables."

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