Agencies tighten as strong factory orders lift Treasury yields; investors await data

By Kenneth Lim

Boston, Aug. 31 - Agency spreads continued to narrow Wednesday as better-than-expected economic data pushed Treasury yields higher.

But market activity remained muted ahead of key economic reports Thursday and Friday.

Bullet spreads closed about 1 basis point to 1.5 bps tighter versus Treasuries across the yield curve on the day.

"Agencies are doing pretty darn good," one agency trader said, noting a "very, very slow day, but some good interest in the front end of the curve, as far as buying goes, in two- to five-years in bullet land."

Callables had another active session, with step-up structures drawing the bulk of investors' interests. But callable valuations have gotten so rich since the recent drop in yields fueled callable demand that some investors are simply buying bullets instead.

"A lot of bullet-type trades and bullet issues in the front end," the trader said. "With seven-years and in, and probably the entire curve, where people tend to buy seven-year, one-year non-callable or three-year, one-year non-callable notes, those are so tight to bullets now that they can just do a bullet instead."

Yields reverse course

Yield levels rose on Wednesday, reversing direction for the third straight day, as the latest economic data soothed the market's worst fears about the economy.

The ADP employment report showed 91,000 new private jobs created in August, less than the 109,000 created in July. Market consensus was for 110,000 new jobs.

Factory orders, however, rose by 2.4% in July after falling by a revised 0.4% in June, according to the Commerce Department, a better improvement than market expectations of a 2% gain.

The market placed greater emphasis on factory orders because of a weak link between the ADP report and the official non-farm payrolls report, which is due Friday.

"I think the market's learned to take ADP with a generous pinch of salt," one market source said. "The market put a little more weight on factory orders, which came in quite a bit stronger than expected."

The source added that the market has been unable to hold on to gains or declines in yields because of the low coupons and high volatility.

"There's still a lot of fear about the economy and about Europe, and that's keeping yields depressed," the source said. "But at the same time investors are not happy about having to accept 2.17% for a 10-year note, and the market's natural inclination is to push for higher yields whenever it can.

"So you kind of have two pretty strong forces pulling on yields, and that's giving us the volatility that we're seeing."

Calm before potential storm

The trader noted that trading volumes have been extremely light, suggesting that many investors could be keeping to the sidelines ahead of Friday's non-farm payrolls and unemployment rate numbers.

"I think that's what a lot of our accounts are doing," the trader said. "We're seeing a slowdown in activity compared to last week...I'm not sure what we're going to see tomorrow or Friday, but there could be some people setting up ahead of Friday's numbers."

Although agencies narrowed versus Treasuries on Wednesday, the bulk of that move was led by swaps, the trader added.

"Swap spreads are a little bit tighter, so it's just pretty much a tandem trade with swaps," the trader said. "Those who are hedged with swaps are just generally tightening their spreads just to keep pace."

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.