Agency spreads widen; spreads underperform swaps following week's supply-driven rally

By Kenneth Lim

Boston, July 22 - Agency spreads widened on Thursday as investors took profit from recent tightening and low absolute yields.

Bullet spreads loosened versus Treasuries by about 0.5 to 1.5 basis points across the yield curve on a steady sell-off throughout the day. Some of the weakness came amid talk that foreign investors were selling their paper.

"Agencies were not that great today," an agency trader said. "[Agency spreads] definitely underperformed swaps by quite a bit. I heard of some overseas selling."

Trading volumes were decent given the time of the year.

"Trading volumes were medium, to be honest," the trader said. "People would say they're low, but they're not low for the summer."

Callables remained the one bright spot in the market.

"Callables are doing well," the trader said. "But the funding levels that the [government-sponsored enterprises] put out are kind of steep, kind of rich, so you really have to pick and choose your spot."

Profit-takers emerge

The agency weakness on Thursday was attributed to investors hoping to cash in on the spread tightening and falling yields over the past few weeks.

"We have been tightening quite a bit in the past few weeks, so it's only natural to take a pause," the trader said. "With the outright rate market so low in terms of yields and spreads being so tight, it's only natural that some people take profits."

The agency market has been a resilient force amid the flights to and from quality that have swept through the bond and equity markets, the trader added.

"I don't think agencies are really a flight to quality product one way or the other," the trader said. "They're kind of steady. It's pretty straightforward. If swaps are in a lot, we'll underperform. If swaps widen out a lot, we'll outperform."

The sentiment among agency investors has been more of repositioning than panic, the trader said.

"The recent agency rally hasn't been panic," the trader said. "It's more of people resetting their expectations."

Tighter week

Despite Thursday's widening, the agency market looks to be slightly tighter on the week as the weekend beckons, the trader said.

"On the week, just off the top of my head, I'd say we're slightly tighter," the trader said.

The market's early rally was because of a lack of supply for investors eager to put their money to work in agencies, which pay better yields than Treasuries.

"I think that's kind of what happened earlier this week, not getting enough supply," the trader said.

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