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Treasury prices continue to hover around the prior session’s low after a surprise bout of selling yesterday. We say surprise bout of selling as prices seemed to give way in the face of a slack initial regional Fed survey reading and against a rather noted washout in US equity prices. Apparently portions of the trade were speculating on the eventual Fed exit from its aggressive easing stance and therefore the weekend articles are apparently having an impact on the Treasury market. We also think that the market needed to juice yields a bit to give the rather large $44 billion in 2 year note auction a more favorable environment today. The market might see some minor pressure from a Case-Shiller home price survey due out early in the session today, as the trade expects to see a minor gains in that reading.
With the market not expecting much direction from the Conference Board Confidence reading, the bigger reaction is likely to come from the initial home price readings. We get the impression that the Treasury market is set to see a somewhat major pivot point this morning, in the results of the 2 Year auction at mid session. While the mountain of supply flowing to the market naturally creates a long series of “tests” for the US, a steep break down in prices, ahead of the brunt of the auctions this week would mean that any disappointment could serve to jack up US mortgage rates! In fact, December bonds to the overnight lows were within 11 ticks of the lowest price level in 2 months and a negative reaction to the auction today could in a sense make it more difficult for commercial real estate and the regular US housing market to recover.
We have to think that the Fed is poised to pull out all the stops in supporting the mid day supply roll out. There are some players who think that the Fed might not support the market today and that an up tick in US interest rate expectations in the wake of a failed auction might go a long way in dampening surging inflationary expectations. In fact, a slight surge in interest rates would also have the impact of boosting the Dollar further, which in turn would prompt an aggressive washout in a host of physical commodities. Therefore, the Fed has to weigh the pros and cons of allowing market forces to run their course, or do they continue to hold rates down to insure a recovery.
We can’t rule out a spike down effort early in the trade today, but on push down in December bonds, aggressive traders might get long for an auction bounce as the Fed and the Obama Administration can’t afford to increase the burden on the US economy just yet. Less aggressive traders might try to buy the December bond calls, looking for a recovery bounce in that call option before the close. If you think the Fed is going to allow a slide in Treasury prices today, then purchase the December bond puts. Critical buying support in December Notes is seen down at 116-20 this morning.
