boring night again, but don’t be fooled: this is getting interesting (Wednesday)

Market traded in another tight range overnight, slightly better to risk since early London, but no thematic price action to speak of. Today’s commentary will be more about what is going on in the long end of the curve. As of 9:00 AM ET, Treasuries are either side of unchanged, the early Treasury flattening turning into a small steepening since mid-morning in London. Meanwhile, US equity index futures have shrugged off some early lethargy to trade marginally firmer.

The big story on the boil here this week is the long end of the curve and the upsurge in demand that we discussed was possible last week. In a nutshell, it is here. Monday night, Treasuries were under pressure throughout the Asian session, as Treasuries experienced some indigestion from Monday’s 5y and the AT&T deal, there was even more pressure from a sloppy JGB 40y (bid into auction and just couldn’t maintain) and some good selling of US 30s against the 06/51 Aussie issuance. Several dealers advocated buying that issue against US T’s adding to the pressure.

But then this article hit: US fixed income turned on a dime for the London open, rallying 4.5 bps in 10y and 7 bps in 30y space. Then, when the dollar started to break lower in early London, eventually testing the 105-handle, it was nothing but buying of yield out of Asian accounts ahead of NY arrival yesterday. MBS, spread product, and even corporates benefited from the buying. Of course, you saw who bought the 7y supply at auction as well yesterday, right?? Late yesterday, we wrote that if the dollar stays below 105 against the yen, then lifers will get more aggressive and look for them to buy ultras along with spread product as they have been doing consistently since June.

Fast forward to last night now. Yen hangs out at 105ish for most of the Asian session but breaks lower after Tokyo lunch and what happens? Yep, Japanese lifers lift WN futures, Asian central banks take WN and mortgages, while Asian banks actually buy in US 2s and 3s. The buying was smaller than Monday night/Tuesday activity, but still gives us a clear picture of how this is shaking out, yet again. Treasuries benefited early from a bid to JGBs and Aussie rates, with Asian curves bull flattening. After the buying subsided, there was some European profit taking in US 10s, paying in USD 7y swaps, and flattener unwinds in UST 5s30s that helped steepen Treasuries and bring us lower in rates on the session. There was fast money selling of 10s after NY arrived as well. But then after the Chicago open, it’s been nothing but buying, this time in the belly.

There appear to be several factors behind the bid to Treasuries in general and the long end in particular, some of which are legit and some of which are quite questionable. 1) The Nippon Life article just highlights the situation in Japan, and by extension the rest of the world. With yen rallying here, all these accounts are adding Treasuries on an unhedged basis, a pretty powerful trade and one they did back in June. 2) Last night, Fitch maintained Japan’s sovereign rating but lowered the long-term outlook to negative, a reminder about the value of US debt (no wisecracks). 3) US lifers/LDI account are in the same boat as their Asian-based counterparts, and have been aggressively receiving fixed, getting long US 30s on TRS, and adding agency MBS whenever they can, but they are fighting the rest of the world for the rations. 4) Month end extension is at .09 years for Treasuries, so there should be some demand for duration this week. 5) (This one I have the most issue with) There are a number of stories since Monday that the Fed may announce they are extending the duration of the buyback program. Fair enough, but seems like that story came out just in time to fit the move. There is a 6, 7, and 8 a well, but sometimes it helps not to over analyze….

Internationally, JGBs rallied .5 bps in 10y space, but 2 bps in 30-40y space as supply in the long end is slowing markedly over the several weeks (only 1 30y auction), while Aussie 10s gapped higher on the open and then sat there all night as the large 31y syndication from yesterday was digested. Aussie 10s closed 5.5 bps lower in yield while Kiwi 10s closed 2.5 bps lower in yield, both curves of course bull flattening. Gilts are slumping under pressure from a mediocre 3y auction and a very soft 8y auction, also weighed on by slightly better mortgage approvals. A very solid German 15y bund auction has offset better selling of bunds by macro accounts, both outright and on spread against Portugal and Spain. Some earnings beats in the UK have helped underpin risk, with most European bourses slightly higher, after China bucked the US trend yesterday and closed firmly higher (2-2.6% better) across its major indices last night while the rest of Asia suffered.

The only thing that matters today is the Fed, although it really shouldn’t. But then again, sometimes when the market expects its friends to deliver they actually do, and maybe today will be that day. Statement at 2 PM ET, press conference at 2:30.

Okay, really hate this whole market thing. We held pretty aggressive support levels in cash 30s and TY contract after the early NY pressure this morning and are now working our way higher, bull flattening of course. And it IS the FOMC, and we SHOULD expect a bigger range, and this market is STUPID, so there you go. For choice today in TYU, let’s call the range at 139-30+ to 139-16+ with risk to taking out the upside level after the FOMC, albeit on less than zero conviction after an overnight range of 139-24 to 139-18+. Support in TYU comes in at 139-16+ objective, 139-12, 139-07, 139-01+, 138-28, 138-23; resistance comes in at 139-25, 139-30+ objective, 140-02, 140-06, 140-08, 140-14.

Watch 1.20% in cash 30s, break it and you just get long, don’t ask questions; we are close at 1.22% right now. The only way you take the pressure off is to get back above the 1.342% reopening level in the bond from the auction at the beginning of July. Bond vol trades very whippy, extremely flow driven. If by some grace we get a seller in classic bond puts, it would be great to get long a synthetic call via the 25% delta USU 179 put for 4.00 BPV (i.e., paying 32/64s and buying 25% USU for 181.16, which just happens to be 3/64 below the current bid, but this thing trades that way). That’s my two cents worth, as useless as it may be….

Have a great Hump Day,