cauldron a ‘bubblin a few days early, and risk heads for cover (Wednesday)

Europe is leading another day of risk off sentiment, but this one seems to have a bit more staying power. Yesterday’s story at 4:55 PM ET that France planned to shut not just it’s three largest cities but the entire country and not just for 3 weeks but for a full month set the tone. Announcement of Merkel meeting with State PMs later today only added fuel to the fire. As of 9 AM ET, Treasuries are 1.5 to 3 bps lower in yield, flattening out to 7s and steepening from 10s out to 30s, while US equity index futures are down over 1.5% shortly before the cash open.

Treasuries saw better buying from the outset, on the combination of Asian real money lifting for month end and CTA buying of TY and US contracts through former resistance levels. That said, Japanese real money wasted little time stepping in to sell 7y and 10y as they have for over two weeks running now. Treasuries drifted back down to unchanged as equity index futures bounced slightly. There was also a block buyer of 10K TYZ 137.5 puts for 14/64, outright at 10:46 PM ET, dumping $175K of DV01 in 7y sector. However, the bid reemerged before Europe opened as bunds ticked higher on talk of the increased restrictions in Germany, with hedge funds lifting bunds and then 10s. Usual central bank buying of 10s showed up, but this time with 20s instead of WNZ futures. The actual European open saw a better bid for risk off assets as hedge funds, real money, and dealers all lifted belly of Eurozone and US curves. There was a block seller of 6777 TYZ at 4:07 AM ET for 138-31, a dump of $600K in DV01 for the 7y sector; the market easily absorbed that flow. German rates lead the rally here, further aided by large widening in peripherals (8 wider in Italy, 10 wider in Greece, 2 wider in France, you get the idea).

Swaps were quieter overnight, some month end receiving went through when Asian real money received in USD 10y and 20y swaps before Tokyo lunch, while RV account did 5s30s steepeners and hedge fund paid in 5y10y forward into European morning. Flows were fairly light though, especially against the past few days when swaps had been much more active as opposed to cash Ts and futures. Swap and credit spreads in Europe steadily widening all morning, in some cases aggressively; this is keeping spreads bid in US as well.

Asian session was fairly tame on the domestic front after everything repriced post US trade on Tuesday and the late news on French lock down. There was again decent foreign buying of New Zealand 10s and some year end buying of Aussie 10s (year end of Oct 30 for a few firms), but nothing to write home about. JGBs closed .5 bps lower in yield, while Aussie 10s closed 2 bps lower and KIWI rates saw yields drop 4.5 bps. Asian stocks were mixed, but fairly tame after NASDAQ put in decent day yesterday. If today continues for US equities, there will be some serious repricing come tonight.

European session has been pretty one-way given the news overnight (European time) for France and the growing issues in Germany and Italy. Early in the session there was some good two-way flow in schatz (2y) futures, before swaps got going, that saw dealers trading aggressively with hedge funds; after swaps opened, there was a quick 1.5 bps widening as expected in basis. Credit spreads widened even further, resulting in more buying in bobls and bunds. Widening in peripheral spreads resulted in good buying in bunds as well to hedge. All of this helped bunds lead the rally in core fixed income in Europe and the US. UK spent most of the morning following bunds. Supply was sloppy in general, or pulled, but had little impact on trade. UK 10y gilt had a smaller tail than average but fairly uninspired bid to cover; German 15y bund had a large tail but was decently if not aggressively bid. Stocks in Europe are down between 2% and 3.5%, just off their lows as we await the US open.

Today in the US, the only data on tap was the already released Trade Balance and wholesale inventories, neither of which had any impact on the market as there are bigger fish to fry right now. Supply today is daily double: Treasury will issue new record $26BN in new 2y FRN AND (of course) new record $55BN in new 5y notes, both at 1 PM ET. Take your pick or take a scoop of both. Onto more serious things, month end extensions show Treasuries adding .10 years, in line with average for non-refunding months, Germany extends .13 years which is above average, EZ extends .14 years, and gilts contract .01 years after the huge extension there last month. Nothing outstanding here, but it is just ONE MORE REASON to see bidders somewhere behind the market for now.

OK, this week we were looking for the test of 174-17/22 in USZ and 138-30+ in TYZ, both of which were parallel bounces and also .618 retracements off the mid-October sell off. Well, you got ’em, and then some. Will take pains to point out that open interest went UP yesterday in the flattening rally, so the short covering we saw in Monday’s bull flattener was not the driver for a second consecutive day. Hmmmm. Personal view only is, and has been, that we are headed for .66/.60% yield zone in US 10s here, BEFORE quarterly refunding announcement a week from today. But could easily make the case for selling here to see .90% as well. Think that it’s time to keep things close to the vest for the next 8 days, but do think you have to own gamma (which everyone wants to sell starting Monday, which bolsters my argument further). Again, prefer a synthetic call, given my view of the underlying but call/put doesn’t matter tremendously given the view. And it needs to be in US Classic futures, using 20% delta options fully hedged. If you have view into end of the year, you can move out to USF (Jan) or USG (Feb).

For choice today in TYZ, let’s call the range at 139-06 to 138-28+, with a range thus far of 139-02 to 138-27, although that lower barrier seems as if it should be down around 138-24+. Something is not lining up right. Resistance comes in 139-04, the 139-06/06+ objective, 139-10+, 139-16 (.618 back of the larger sell off from 8/4 to 10/22), 139-22; support comes in at the 138-28+ objective, 138-24+, 138-20, 138-12+, 138-08, 138-01, 137-25/24.

All right, good luck out there and have a good hump day,