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The short covering mentality partially remains in place into the opening this morning, with a slightly weaker global equity market bias and perhaps even expectations of decent to good demand track for the first leg of a three leg Treasury auction. With $35 billion in Three Year Notes to be auctioned today, the trade is probably expecting past patterns of good demand at the short end of the curve. With the overall market environment yesterday giving off the impression of a down shift in macro economic sentiment, it is not surprising to see another positive early trade in Treasuries. In the prior trading session, a host of physical commodities were under noted pressure, with the Dollar also on the rise and that seemed to foster technical short covering action in both bonds and notes. In retrospect, the latest COT reports had to be discouraging to the bull camp, as the downward track in prices over the last month has not markedly pumped up the magnitude of the net spec short positioning in either bonds or notes.
In addition to the beginning of the next auction cycle, the market will also see a Wholesale Inventories report, which recently has posted a pattern of contractions. Typically seeing inventories narrow is seen as a sign of increased activity ahead but in the current case, declining inventories are probably a sign that companies remain very defensive and that once the economy turns, many supplies and products could be in short supply. The market is also expecting an announcement on which banks might be allowed to return their TARP money and that could be seen as a beneficial development for Treasuries as that would theoretically reduce the amount of debt that will ultimately be offered by the US government.
With the quasi improvement in the US Non farm payrolls recently resulting in a moderate jump in some yields, the trade is also expecting an increase in demand for Treasury offerings and therefore the coming auctions are going to have a brighter spotlight focused on them. In our opinion, the path of least resistance will continue to point upward and that into the mid session auction results, we suspect that the market might get an additional muted lift because of the concern in the equity markets that valuations are running ahead of reality. In other words, if enough investors think equities are currently expensive or poised for corrective action ahead, that could push money toward the “more attractive” Treasury yields. In short, a return to a recent pivot point of 114-16 in September Bonds and to 113-26 in September Notes is possible.
On the other hand, as we get further into the auction cycle later this week, the odds of a failure in sentiment and another big range down washout will increase. The bulls might get a bounce today but failures later in the week could be quite significant.
