skittish markets but structural short not be happy with last 24 hours….(Thursday)

Markets traded risk off to start a holiday-shortened session, with fears of softening Asian economies and weak European PMI driving the train thus far. As of 8:20 AM ET, Treasuries are 1.5-2.75 bps lower in yield led by the belly/front end, but well off their best levels of the session. US equity futures are effectively flat at this point, having bounced smartly off their overnight lows.

There was better buying of Treasuries from the outset in Asia, with comments from NY Fed Vice President Lorie Logan helping the front end outperform. Asian real money lifted 30s early but switched to 2s and 3s after Tokyo lunch. Japanese real money sold 2s early to stay compliant with FSA demands ahead of Golden Week but used that cash to buy 30s into European hand off. Asian central banks were on both sides of 2y, but again were in lockstep lifting more spread product, although not as aggressively in MBS today as earlier this week. The reality is the pressure from Japanese firms falling behind the FSA’s request to hedge their US bond holdings has lessened dramatically since the wave early this week and it appears the structural short we continue to argue wasn’t closed is being scraped again. Add to that comments out of Japanese government that a planned tax hike could be delayed (read: economy is slowing again), so need to wait and see the June Tankan numbers before implementing. Even a strong Aussie employment report did little to dampen the risk off view, while NIKKEI led Asian stocks lower, with losses between .5% and 1% after the Kyoto story on the tax hike delay.

NY Fed Lorie Logan, in remarks late yesterday before the Money Marketeers Association in NYC, is being blamed by some market watchers for today’s rally in fixed income. She made the case that the size of further purchases by the Fed will have to be larger than earlier because growth of non-reserve liabilities is larger than before the taper. The front end/belly is better bid partly because of these comments for sure (she made the case that the Fed would buy the front end), but this is not some new Earth-shattering revelation.

Soft PMI data across the board in Europe sealed the deal for fixed income, as bunds took the lead after European PMI in the move to lower rates. Some minor concession building for supply in Europe that knocked bunds temporarily back to unchanged kept Treasuries in check early in the European session, but European real money lifted RXM against TYM before the PMI data, and then macro accounts took advantage of this softening to buy US 5s and 10s after the data. European auctions went fine, and options expirations in European equities have helped rally Euro bourses post expiration time. With French auction going well and equities bouncing, some of the risk off pressure has eased. Early US flow saw better hedge fund selling of rich 5s, central bank selling of 2s, and some minor RV buying in 10s. I am saving the potential re-ignition of Italian mess for next week’s entertainment, but it is getting a bit hotter there again.

Phily Fed softness offset better March retail sales data, so now we will wait on PMI data at 9:45 AM ET, before everyone shuts down for the long holiday weekend. SIFMA recommends an early close today at 2 PM ET, while Chicago pits will close at 1 PM ET and electronic markets will close at regular time (4:15 PM ET for stock indices, 5 PM ET for interest rates). US markets will be closed for the holidays until normal Sunday open.

We argued yesterday morning that there was a good chance we had completed something with the trade to 122-20+ in TYM, and that with greater than a 50% chance that level would hold the risk was to a test of 2.52% if we took out 2.58% (i.e., 122-26+ in TYM); we got as low as 2.547% overnight, but the day is young still. Don’t think we are in the midst of the a counter-trend reversal (i.e., the sell off is done), but do think we are being shown the risk in the market again (structural short), albeit contained to the range for the near term. The range has likely been set now for today, with risk being that if we take out 123-05 in TYM, we will rally into single prints from April 12 up to 123-10+ or into single prints above there up to 123-17+…that would be painful to say the least. On the downside, watch 122-26+ level of course (low overnight was 122-27); below there watch that 122-20+ level and 122-14 below there.

Have a great and safe holiday weekend,