Agencies widen as profit-taking from recent tights continues; callable redemptions slow

By Kenneth Lim

Boston, Nov. 12 - Agency spreads widened slightly on Friday as investors continued to take profit, echoing similar weakness in the Treasury market.

Bullet spreads eased out by about half to 1 basis point across the yield curve after investors returned from Thursday's Veterans Day holiday. Treasury yields also rose across most of the curve on Friday.

"Spreads are leaking a little wider," an agency trader said. "Swaps are out a little wider as well, but nonetheless spreads feel just a little heavy here."

Trading volumes continued to be on the slow end of the spectrum with the weekend approaching and the market still sluggish from the recent holiday.

"It's a slow week," the trader said.

Callable slowdown ahead

Callable activity has been slow, and could continue to quiet down as the end of the year approaches, the trader said.

The agencies could slow down their redemptions as the year winds down and rates back up, which could leave a glut of callable supply in the market.

"That's an interesting story," the trader said. "They're going to slow down redemptions with the back-up in the market, and that's going to be partially offset by the fact that volatility is so much higher. But I would expect call redemptions to slow significantly over the next few weeks."

But the impact of fewer redemptions on callable spreads remains to be seen.

"Yes, if there is more supply callable spreads would widen out, but I'm not sure the [government-sponsored enterprises] funding levels are going to widen as well," the trader said. "In fact, they're probably going to tighten."

Heading for normal

Agency spreads have been widening for most of the past week, but the market has not been weakening as much as it has been giving up recent tightening, the trader said.

"We were a little too tight to begin with," the trader said. "You had the two-years at max maturity trading at 7 bps over or something like that. There's just kind of not much upside there. We're now at more normalized levels."

The two-year spreads should not widen out by a lot more from current levels in the near term, unless some major news hits the tape, the trader said.

The Fannie Mae 1.625% five-year notes due October 2015 are hovering around 19.5 bps over Treasuries, and those could still ease out slightly after moving in over the past couple of weeks on optimism about the Federal Reserve's Treasury purchase program.

"I would expect the five-years to get back to the 20s, to be honest," the trader said, "not 29 bps, but more like 22 bps or 23 bps."

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