Agencies close out flat as volatile rates keep investors on sidelines; more bumpiness expected

By Kenneth Lim

Boston, April 1 - Agency spreads closed unchanged on Friday on thin trading as investors stayed on the sidelines to watch rate levels go through a roller-coaster session.

Yields took a bumpy ride during the day after a strong employment situation report caused a sell-off in bonds before dovish comments by a Federal Reserve official calmed the markets.

Bullet spreads ended the day and the week mostly unchanged, an agency trader said.

"Not a creature was stirring," the trader said. "I think people took one look at the headlines and decided to sit this one out. Better to let the dust settle over the weekend before coming back in."

Callable trading was also muted despite the early back-up in rates.

"In most cases, yes, you'd expect to see people trying to take advantage of a back-up to try to capture the coupons, but I think the high volatility that we're facing is causing a lot of uncertainty and a lot of reluctance to be too exposed to that volatility," the trader said.

Rates make late recovery

Yield levels initially jumped early in the day after the Labor Department released a jobs report that came in better than expected.

Total non-farm payrolls rose by 216,000 in March, more than the Street's expectation of 192,000. The country's unemployment rate fell to 8.8% from 8.9%, beating forecasts of an increase to 9%.

"Non-farm payrolls and unemployment were better than expected, which is good for the economy but not so good for government bonds," the trader said. "We saw a sell-off right off the bat this morning after the data came out."

The sell-off hit both Treasuries and agencies because agencies are trading extremely tight to Treasuries at the moment, the trader explained.

"Spreads are very tight at the moment, especially at the front end, so you're going to see very similar moves in agencies and Treasuries," the trader said.

Yields came back down later in the day after Federal Reserve Bank of New York president William Dudley, who is perceived as a policy centrist, warned against cutting back on monetary stimulus too early.

"A stronger recovery with more rapid progress toward our dual mandate objectives is what we have been seeking," he said in a speech. "This is welcome and not a reason to reverse course."

Dudley's remarks eased concerns about the Fed possibly cutting short its quantitative easing policy and even raising rates, the trader said.

"It was the right piece of news to pull the market back from the morning's kneejerk selling," the trader said.

Volatility ahead

But the trader cautioned that the market could be in for more volatility after the weekend. One prime concern will be whether the inflation hawks or the doves will hold bigger sway in the Fed.

"When we come back on Monday, the question will be who's going to win this policy battle at the Fed?" the trader said. "We've had two voting members come out for tighter policy and Dudley today pushing against tightening. That's our new source of uncertainty."

Agencies could have another quiet week if Freddie Mac decides not to issue new Reference Notes on its calendar slot on April 5.

"Most people I spoke to expect them to pass, so it could be another quiet week for agencies," the trader said. "It's good for spreads, but it's not good for volumes."

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