the steady grind continues as risk can’t catch a Summer break….(Wednesday)

Risk off tone remains the theme this last week of May, as global concerns and the continuing saber-rattling on US/China trade do little to ease the global tensions (overnight China has threatened to use “weaponize rare earths”, which maybe someone can explain what that actually means to this old person). Volume and activity have been fairly brisk for a second consecutive session. As of 9 AM ET, Treasuries are 3.25 to 4 bps better in a small bull flattener, while US equity index futures are in the middle of a slow leak, currently down just under 1% ahead of the cash open.

Treasuries opened flat to 3 PM marks in Asia, but some late deal-related buying by US bank in belly of curve resulted in 10y taking out 2.25% in cash 10s along with yesterday’s high in TY contract; CTAs were buyers of TY and US contracts through the highs, with stops pushing the market a quick 1.5 bps lower in yield. Asian real money was a better buyer of 5s early in the session, with Japanese real money lifting 30s; after Tokyo lunch, Japanese real money turned better to sell 5s and 10s in USTs, in some cases buying spread product or receiving in US 7y and 10y swaps. Central banks were back today, buying more spread product, more axed to MBS after yesterday’s widening. Locally, Aussie rates led a better performance, with Aussie 10s making a new all-time low through 1.5% and inverting to funding curve for the first time in a decade. Kiwi rates also set a new record low at 1.719%, while JGBs drifted higher in sympathy. Japanese stocks led the region lower, but there was an interesting bounce in Chinese shares late in the session that was led by Shanghai and Shenzhen indices.

After Treasuries flat-lined at better levels for the last two hours of the Asian session, the risk-off bid returned shortly after the European open. Soft French CPI took some of the blame, but reality is Italian debt issuance after two days of aggressive widening, Brexit concerns, and Bolton comments on Iran all played a role in the dour sentiment. Peripherals are actually trading well this morning, after Spain made a new all-time low in yield (.740%). A soft German employment number mid-morning (unemployment +60K vs expected -8K, ooops!) helped to engender another minor risk-off move, as eminis traded through 2800 and DAX broke 11850. Flows included leverage buying of FV and US contracts mid-morning in London; deal-related paying in USD 7y and 10y swaps; European bank paying in USD 10y swaps and GBP 5y swaps; macro account buying of SPGBs and PGBs against BTPs and bunds; domestic bank buying of BTPs outright; central bank buying of new US 5s and more spread product; and, better US portfolio buying of 10s and receiving in USD 10y swaps when NY arrived. A good bobl auction resulted in follow-through dealer buying in belly of German curve, and bank was better buyer of gilts outright and on the curve against 2y gilt paper. DAX and CAC leading European equities lower, down over 1.5%, and exerting pressure on US equities ahead of the open.

Today’s release calendar is rather bare, with mortgage apps already out, and only Richmond Fed at 10 AM ET left, as there are also no official appearances scheduled either. This month’s refunding will be the event(s) of the day as Treasury will issue $18BN in 2y FRN at 11:30 AM ET and wrap up the 2-day fundraiser with $32BN in new 7y notes at 1 PM ET.

Okay, so for review, let’s look at what has been driving the market this week, not necessarily in any order:
1) month end extensions, which at .11 years for Treasuries are large, but not anything extraordinary for a quarterly refunding month;
2) break of 2.35% and now 2.25% in cash 10s, which has resulted in numerous pieces about the next “refi” wave but more likely is just about taking out some technical levels as there really isn’t anything out there to prepay (other than defaults, which are a conversation for a DIFFERENT day);
3) Italian debt widening over 20 bps to core since Monday, which certainly has engendered a global risk bid;
4) speaking of global, just in the last 14 hours we have seen Australia, New Zealand, and now Spain make new all-time low yields in the 10y sector, which perversely forces in more buying from indexers;
5) Brexit, which is more a drag than a driver, but it’s out there, just like a bad dream; and,
6) geopolitical tensions, both military and financial, as there is something obviously afoot in the Middle East and China remains a very dangerous situation. What once looked to be a very well-orchestrated and managed maneuver by the US administration is now threatening to come off the rails as China looks at new ways to retaliate.

I think that about covers it. In essence, none of these issues alone are a problem that should rattle markets this much, while #2 and #4 are arguably consequences of the other four drivers but now have taken on lives of their own. Let’s see how this plays out, but with month end, look for supply to go well today and long end to stay better bid into Friday morning. So for choice today, call the range in TYM at 125-29 to 125-17+ (low overnight was down at 125-12, but you should hold test of 125-17+ when equities try to bounce early). Resistance comes in at 125-25+, then the aforementioned 125-29, 126-03+, 126-11; support comes in at t the 125-17+ level, 125-14, 125-11, 125-08, 125-01. If anything, want to lighten up on long gamma positions later today or early tomorrow; it’s too rich to buy up here, although it is never wrong to add some vega strategically as there is a lot going on that will pressure long tenors this lovely Summer….

Have a great Hump Day,