Agencies keep pace with rallying Treasuries amid weak equities, dim economic outlook

By Kenneth Lim

Boston, June 10 - Agency spreads closed flat on Friday, benefiting slightly from some yield hunting as Treasuries staged a rebound.

Bullet spreads ended the session unchanged versus Treasuries, with the longer end of the yield curve a "smidgeon narrower," said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson & Co.

Trading volumes were extremely light with the weekend beckoning.

"Activity today was actually fairly light," Hurley said. "We saw heavier activity earlier in the morning, but it has really wound down since then. There was a lot of buying in agencies more out to the 10-year area."

Yields fall again

Yield levels declined again after rising on Thursday. Friday's action was seen as a reaction to struggling equity markets and views that the U.S. economy will take longer than expected to get back on its feet.

The 10-year Treasury yield fell back below the psychologically significant 3% level to around 2.97% late Friday.

But the falling yields have also made Treasury coupons look less attractive to investors, pushing some money out on the risk curve to seek better returns. Agencies, which are seen as just a step down from Treasuries in terms of risk, were a natural place for investors to look.

"As Treasuries continue to move higher, more people are flocking to the agency market for safety and just to get a higher yield than in Treasuries," Hurley said.

The callable market also saw strong interest, and Friday's callable market was one of the more active sessions over the past week.

"Today is one of the heavier days we've seen for new issue callables," Hurley said. "People reason that if they're buying in these low interest rate environments, they're going to go for call protection just to get the yield."

Investors who buy callables take on the risk of the debt getting redeemed early, but they get to enjoy higher coupons while the notes are not called. Because issuers are likely to call notes in a prolonged low-interest rate environment like the one that the market is operating in, investors have been seeking shorter, one-time structures that have more restrictive redemption conditions.

"People are going more for the one-year, one-time calls," Hurley said. "If it's not called, it turns into a bullet security, so you retain a higher coupon ... and it's going to narrow versus Treasuries because non-callables always trade at a narrower spread than callables."

Fannie Mae announcement ahead

The coming week will see Fannie Mae make an announcement on Benchmark Notes issuance on Tuesday.

In terms of economic data, the producer and consumer price indexes will be released, as well as housing starts numbers and the consumer sentiment index.

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