Agencies narrow; 30-year Treasury auction tails by 10.5 bps; long-end debt still soft

By Kenneth Lim

Boston, Aug. 11 - Agency spreads tightened Thursday as back-end yields jumped on a weak Treasury auction and mixed jobless claims numbers, although front-end demand remained strong.

Bullet spreads closed the day about 2 to 3 basis points narrower versus Treasuries.

"Agencies performed fairly well," an agency trader said. "They outperformed Treasuries and swaps."

The callable market also had a positive session.

"Callables opened up tighter this morning by 3 to 7 bps, then when we started getting more concern out of Europe, we widened by 2 to 3 bps, and we're ending tighter by about 3 bps," the trader said.

Yields rebound

Yields finally rose on Thursday after falling all week, as a surprising drop in jobless claims precipitated a wave of profit-taking.

New jobless claims in the week ended Aug. 6 fell to 395,000 from a revised 402,000 in the prior week, the Labor Department reported Thursday. Economists were expecting a gain in claims to about 405,000.

But the shine of the latest number was dulled by the fact that the earlier week's number was revised higher from 400,000, suggesting that the labor market was weaker than previous numbers indicated.

"Initially when it came out a little bit better, there was some optimism, but then they revised prior weeks worse, which kind of offset the positive number," the trader said.

The market was also discouraged by an exceptionally poor $16 billion auction of 30-year Treasury bonds, which tailed the 1 p.m. bid by 10.5 bps.

"Boy, that was a disaster," the trader said.

Agencies easily outperformed Treasuries on the day on the back-up in yields, especially in shorter maturities.

"Agencies that performed the best were inside of seven years," the trader said. "There's huge demand in the front end right now.[There's] a lot of cash in the system, a lot of cash from outside the U.S. as people shed risk on concerns about Europe."

The longer end of the yield curve has been a little weaker because of longer-term uncertainties. While the Federal Reserve's statement earlier in the week that it will keep the currently low short-term interest rates until mid-2013 has supported short-term yields, the risk of rising rates beyond the belly of the curve remains a significant concern.

"There's a little bit too much risk in the long end right now," the trader said.

Navigating volatility

The market's volatility over the past few weeks has been a struggle for many investors, with yields trading in a range of more than 100 bps since the middle of July.

"Going into the debt ceiling debate we did lighten up because we weren't sure what was going to happen, and we did shrink inventories quite dramatically," the trader said.

But investors are more willing to get their toes wet in the current market environment, the trader added.

"Now you try to be fairly nimble, and try to take advantage of the volatility," the trader said. "For example, when volatility pops up pretty substantially, we try to get involved in the market because we know it's going to come back down. You want to go in when volatility is high and get out when volatility is low."

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