Agencies widen as Libor reset, corporate issuance push swaps out; payroll data awaited

By Kenneth Lim

Boston, Jan. 6 - Agency spreads continued to soften on Thursday, dragged wider by swaps and a slowdown in demand from banks.

Bullet spreads across the yield curve were 1 to 2 basis points wider versus Treasuries, an agency trader said.

"Agencies kind of suffered a little bit this morning and into the afternoon as swap spreads started to move out," the trader said. "We've been kind of direction trading with swap spreads."

The intermediate maturities performed slightly better than the ends of the yield curve.

One trader reported seeing "better buying in the belly of the curve."

In general, investors appeared to be waiting on the sidelines for Friday's non-farm payrolls report before making any major moves.

"I would say that we're waiting for payroll data to see the trend in rates," the trader said.

Swaps drag on market

The widening over the past two sessions was blamed on swaps, which lost ground versus Treasuries and put pressure on agency spreads.

Swaps in turn were wider for a variety of reasons.

"I think it was just concern about the reset in Libor," the trader said. "Fives were hot in repo. I saw 3 bps moves in five-years and in. Agencies went out 1 to 2 bps, so they actually outperformed by 1 to 2 bps depending on which part of the curve you look."

Guy LeBas, chief fixed income strategist at Janney Montgomery Scott, said swaps were under pressure from hedging-related trading amid the week's corporate issuance.

"I think the thing going on in swaps is corporate new issue trends," LeBas said. "We're seeing increased volumes of floating-rate issues from corporate, which they will flip into fixed rates."

Bank demand slowing

Freddie Mac's new 1.375% three-year Reference Notes due February 2014, which priced Wednesday, also slipped slightly in line with the rest of the curve Thursday.

The trader noted that the deal saw weak interest from central banks, even after taking into account the fact that they tend to look more closely at two-year issues. On the flip side, domestic investors appeared to have picked up the slack left by the central banks.

But domestic banks are also expected to cut back on their agency consumption as opportunities for better returns and higher risk appetites return to the financial markets.

"I think agency spreads over the week have suffered a little bit because as banks see loan demands pick up, [commercial and industrial loans], or at least a declining level of decline, if that trend continues, banks are going to be reluctant to put agencies on the books."

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