Agencies tighten as investors back up from recent widening; market stuck in trading range

By Kenneth Lim

Boston, May 4 - Agency spreads narrowed slightly on Wednesday as investors clawed back some of the widening from previous sessions amid wariness about Friday's payrolls data.

Bullet spreads closed about half to 1 basis point tighter on the day, but volumes were extremely thin. Investors saw little incentive to trade with no new supply to spark interest after Fannie Mae skipped a calendar slot on Tuesday.

"Nothing's going on," one agency trader said. "Fannie Mae passed, so spreads have kind of been steady."

The callable market has also been quiet, with recent declines in yield levels dampening issuance volume. Demand for callables generally picks up when yield levels are higher because the coupons are more attractive.

"The primary is slow but secondary callable trading here has worked out," the trader said. "But inventories are light, which should support agency spreads."

Yields fall further

Yields fell on Wednesday as bond markets benefited from lackluster economic data.

The Institute for Supply Management reported a drop in its U.S. services activity index to 52.8 in April from 57.3 in March. Economists were expecting a slight improvement.

Private payrolls also rose 179,000 in April, according to the ADP National Employment Report, below Street expectations for a 198,000 increase.

"Yields moved down pretty sharply on the data," one market source said. "We had a pretty weak Q1; people are worried about whether it was going to continue into Q2. Not a good start to the quarter."

The market is now set up for a weak non-farm payrolls and unemployment report on Friday, one of the most important economic data points on the calendar, as well as jobless claims numbers on Thursday.

"The Street's expecting a disappointment," the source said. "I don't think yields will go back up this week unless non-farm payrolls is surprisingly strong."

Agencies stuck in range

Agency spreads managed to come in slightly versus Treasuries on Wednesday despite the rally in Treasuries because the market is reluctant to break out of the current trading range, the source said.

"Agency spreads widened a little yesterday, and today was just a matter of coming back in," the source said. "I don't think it's anything more meaningful than a technical move. I think agencies are going to stay range-bound for the rest of this week at least."

Investors are reluctant to make any major bets ahead of the coming economic data, the source said.

The current supply drought is also helping to keep spreads at current tights. The agencies have significantly cut down on issuance this year because their funding needs have not been great, while Fannie Mae and Freddie Mac also have to meet federal requirements to trim their portfolios.

In fact, agencies may struggle to break out of the range.

"Agency spreads are already very tight, so on the tight end it's hard to get any tighter," the source said. "On the wide end, the lack of supply is really maintaining a pull on spreads, preventing them from getting too wide. It's kind of boring, really."

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