Agencies tighten as rate buyers target ends of yield curve; low liquidity plagues market

By Kenneth Lim

Boston, Dec. 9 - Agency spreads narrowed slightly on Thursday on absolute rate buying at both ends of the yield curve.

Bullets closed about 1 basis point tighter versus Treasuries across the yield curve, an agency trader said.

"But we underperformed swaps, which ran about 2 to 3 bps tighter," the trader said. "But we outperformed swaps yesterday, so considering the recent moves, agencies have actually done pretty well."

Callable issuance was decent, with most of the deals spurred by reverse inquiries.

"Callable hasn't been huge...because there are a lot of bonds on the books, and a lot of underwriting is driven by clients rather than dealers waving new callable bonds in the market," the trader said.

Most of the callable demand is coming from the retail segment of the market after rates backed up over the past few days, the trader added.

"The majority is driven by retail clients, because these are great yields for them, so they're buying that," the trader said. "The central banks, it's year-end for them, so they're not really doing anything now."

Buying at ends

Most of the buying on Thursday was concentrated at the ends of the yield curve.

"There were a lot of buyers in the front end, 18 months and in, and also some buyers further out the curve just based on dollar yields," the trader said.

The buying in long-end agencies was unusual given the jump in long Treasuries.

"Usually when [Treasury] 10s and bonds are up, agencies don't do as well, but agencies have just been hammered so much recently that there are still attractive levels in agencies at 40 to 50 bps over," the trader said. "The belly of the curve is a harder sell, and twos and in are doing very well."

On the whole, the agency market has been relatively stable given the underlying volatility in the Treasury market over the past week, with bullet spreads mostly holding firm.

That stability is partly due to the quiet primary market, after Federal Home Loan Banks on Wednesday decided not to issue benchmark bullets this week. The other explanation is that investors simply aren't paying too much attention to agencies at the moment.

"The problem is there's such huge volatility in the market, most traders are watching the callable books instead of bullets and spreads," the trader said. "I think clients, and on the buyside especially, they're watching the delta more than anything else. So first you watch your outright risk and then you watch your spread risk.

"In this kind of an environment that's the most important thing," the trader added. "When the market calms down and reaches equilibrium, then you go, OK, let's look at the spreads."

Possible tightening ahead

The tightening could continue on Friday as investors come back to the market following the conclusion of the week's Treasury auctions, the trader said. The main risk is that the high volatility in the market right now makes it difficult to predict what lies ahead.

"The game plan had been that going through the 30-year auction [on Thursday] the market on Friday should do better," the trader said. "I think it will depend on stocks, but I would think, absent anything overnight, I would expect the market to be slightly tighter."

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