Agencies widen as investors ease off recent tights; volumes low on market's richness

By Kenneth Lim

Boston, Oct. 22 - Agency spreads softened slightly on a quiet Friday as investors took a break from recent tightening.

Spreads at the front end of the yield curve, which are already extremely tight, did not move much, traders said. The five-year sector was off the week's tights by about 1 basis point and slightly wider in longer maturities.

"We're a little bit softer with swap spreads," one agency trader said. "Volumes are slightly softer. Buyers are a little reluctant after the last day or two of tightening."

Slow trading

Trading activity was slow, even for a Friday, in large part due to the richness of the market as well as uncertainty about details of the Federal Reserve's expected decision to restart quantitative easing.

"The activity has been pretty much light for the past one week," another broker said. "The spread of front-end agencies to Treasury bills has been pretty tight, especially inside of six months, about 3 to 4 bps over bills. Further out the curve it kind of steepens, with one-year spreads about 4 to 5 bps over bills."

Longer maturities are seeing most of whatever activity there is in the market, the first trader said.

"Agencies are still reasonably priced to Treasuries there," the trader said. "They're about 25 to 40 bps over Treasuries out in the long end of the curve, but we feel they could probably widen a little bit more."

Demand still strong

Despite the slow activity, investor demand remains strong for agencies, the trader said.

"We've definitely seen good interest in agencies five-years and beyond," the trader said. "In part that's because they've been pricing it right."

The agency yield curve is also steeper than the curves for swaps and Treasuries, mostly because supply of long agency bullets has been practically non-existent since the financial crisis. Swap spreads in the 30-year sector are about 40 bps through Treasuries, while agencies are about 45 bps over matching maturities, the trader said.

"There's no supply, and I don't really anticipate any supply," the trader said. "The roll-down characteristics are very attractive for agencies."

In the week ahead, Fannie Mae has a calendar slot for issuing Benchmark Notes on Wednesday, before the market turns to the Federal Open Market Committee's Nov. 2-3 meeting.

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