Agencies tighten on flight to quality, Treasury dip; safe-haven bids spur outperformance

By Kenneth Lim

Boston, March 17 - Agency spreads narrowed slightly on Thursday as the market benefited from both a retreat in Treasuries and continued flight-to-quality demand.

Bullet spreads closed about half a basis point tighter versus Treasuries on Thursday, while the five-year sector came in by about 1 bp.

"We saw general customer buying interest in covered bonds as well as agencies," one agency trader said.

The callable market saw activity pick up slightly, said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott.

"Callables have seen slower new issuance, but today was a little busier," he said. "About 40 deals printed, but what I would say is those deals stopped at about 1 this afternoon."

LeBas was referring to the start of the U.S. college basketball playoff tournament Thursday afternoon, adding that the games may have been a significant distraction on trading desks. St. Patrick's Day celebrations may also have played a part.

"I'll say the market's quieted down a good bit at the start of the NCAA tournament," he said. "In fact, it's very, very noticeable. We had a busy morning, but things quieted down in the afternoon. And then you have St. Patties, and half of the traders are Irish anyway."

Strong week

Agencies enjoyed a relatively positive week, the trader said.

"We've seen agencies improve versus swaps and Treasuries over the last week," the trader said.

The trader said disaster-stricken Japan and unrest in the Arab countries have generated safe-haven bids that have helped agency yields keep close to Treasuries while outperforming swaps.

"Agencies have been almost trading like Treasuries," the trader said. "It's more a reflection that the crises that everyone's facing is international in nature."

LeBas agreed that agencies were being propped up by nervous investors.

"I really think it comes down to the risk aversion bid here," he said. "As events in Japan have evolved, there's been a bid to safety."

Economics take back seat

The day's economics data did not have a major impact on spreads, although they did help absolute yield levels to rise, LeBas said.

New jobless claims fell 16,000 in the previous week to 385,000, the Labor Department said Thursday, a larger reduction than economists were predicting. The four-week moving average fell to its lowest level in more than two years.

"I think that wasn't really a factor in today's market actions," LeBas said. "It certainly helped...I'm more interested in the continuing claims, and the four-week moving average, which was strong."

The Consumer Price Index also rose 0.5% in February, the fastest monthly gain since June 2009, increasing inflation concerns and yield levels.

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