EM pressure but something afoot in Italy causing divergences… (Wednesday)

The little game of EM Whack-A-Mole continues with today’s hot zones being South Africa, the Philippines, and Indonesia, but don’t turn your head or another one might pop up. Risk trades defensively as a result, even in the face of seemingly positive developments in Italy, with US bearing the brunt of the core pressure given the EM focus. As of 8 AM ET, Treasuries are 1.5 bps lower in yield in the belly, less so on the wings, while US equity futures are trending marginally lower but have cut their overnight losses in half since NY walked through the door.

Treasuries opened to slightly better levels early in Asia but came off after Aussie bonds got slammed on strong local data, with Aussie Q2 GDP printing +.9% vs consensus of +.7%. Aussie bonds gapped 3-5 bps higher, with the 3y bearing the brunt of the selling before retracing some of the move on leverage account covering of Aussie 10y shorts. Good demand for JGB 10y supply allowed Japanese fixed income to largely ignore their neighbor’s move, with JGBs closing 1 bps better in 10y sector, slightly lesser gains on either side of the 10y sector. As for Treasuries, Asian real money was an early buyer of 10s, but hedge fund paying in USD 10y swaps and other leverage accounts selling 5s and TY contracts on the Aussie data pressured the complex before better Asian bank buying of 5s steadied the market. Later in the Asian session, there was hedge fund adding of 5s30s steepeners in Treasuries along with Japanese bank buying of 3s. Stocks followed yesterday’s US lead to close lower, with Chinese shares losing as much as 1.9%; the Jakarta Composite Index was notably down 3.75% on the currency woes.

The early European session saw the height of the Asian EM currency issues, as Treasuries saw a small flight-to-quality bid that lasted until mid-morning in Europe when Asian bourses were finally closed for the session. In stark contrast, bunds have spent the session under pressure as developments in Italy are being viewed positively and Italian 10y has tightened around 14.5 bps to bunds thus far today. The South African Rand came under early pressure on budget concerns and added one more dose of pressure to Indonesia and the Philippines while mixed European PMIs didn’t help the risk sentiment. However, developments out of Rome (Salvini plan and meeting with government– notice, nothing concrete) were enough to seriously bid Italian banks (+4-5.5%) and BTPs; UK service PMI print of 54.3 vs expected 53.5 helped further steady risk in Europe and help take US equity futures off their lows. Domestic banks were good buyers of 1-4y BTPs, with banks buying 3-6y sector, and asset managers buying long end of BTP curve to sell long end of SPGB curve. Bunds saw RV selling against 10y BTPs, macro selling of bobls in good size (3 large clips between 131.48, 131.43, 131.38), real money buying of schatz, and deal-related paying in EUR 10y swaps. Gilts came under pressure from hedge fund sales in 10y space after the PMI data but biggest story in UK rates today is early large demand to add 40/45 year paper against selling 20y gilts; that curve flattened markedly throughout the early European morning. Treasuries saw good currency-related demand in 2s and 5s early in the European session from real money accounts, European bank buying of 5s and 7s, more levered account interest in 5s30s steepeners in Treasuries, deal-related paying in USD 5y swaps and selling of 30s outright, and macro buying of 10s on the UK PMI-induced pullback. One note here: tomorrow is a very large day for issuance in Europe and today may just be short-covering ahead of the big event. US equity futures have bounced off their lows but remain tied to EM currencies early this Wednesday, while US portfolio account has been a buyer in US 5y space since NY arrived.

Today’s calendar remains lighter, with only trade data scheduled for release at 8:30 AM ET. Fed’s Bullard will speak in NY at 9:20 AM ET, while Kashkari will appear at a town hall in Montana at 4 PM ET. There will be no issuance or cash management activity for Treasury until next Monday.

Yesterday, we got the pullback that was signaled by Friday’s close, but left the market truly unsatisfied as we stopped right between contrasting signal levels. Today is a new day, with new issues to muddy the waters. Still think the pot is working toward a boil, not yet ready to bubble over. Therefore, just don’t have any great ideas, just sticking with the themes: don’t get caught short fixed income and, while one doesn’t need to add vol until it gets a little hotter, make sure to have a little gamma in the drawer just in case the flame flares up. For choice today in TYZ, call the range at 119-31+ to 120-06+, after an overnight low of 119-28+. If we take out 119-31+, we will run down to more important support at 119-27, with additional support at 119-20, 119-12+, 119-07. Take out 120-06+ on the upside and run up to more important resistance at 120-08+ ahead of 120-15, 120-17, and 120-27.

All right, have a good hump day….