Thursday, November 8, 2012

30yr UST Auction Preview

Today is the 2nd of the long-end UST auctions for the month of November (16bln 30yrs will be sold to the market at 1pm...largest single DV01 event of the monthly cycle).  This will be a new 30yr (new cusip, maturity date, coupon, etc..).  Buying bonds in these auctions and holding for 24 hours has been a winning trade for the last 14 new 30yr auctions (that goes back 3 1/2 years since the start of monthly bonds and QE).  Normally, the long end of the UST market has either been selling off or significantly cheapening vs stocks at this point in the monthly cycle.  Today is one of the rare instances where this is not the case (must adjust today's 10yr yield for a 4bp roll to see this is the case).

30yr auction previews have the benefit of analyzing the previous days 10yr auction, which is the 2nd largest DV01 event during the monthly cycle (16bln 30yrs are the equiv of 34bln 10yrs...yesterdays 10yr auction was 24bln).  So, lets first do a post-mortem of yesterdays 10yr auction.

Focusing on price action alone (lets ignore predictions about the election results on the market)...leading up to the 10yr auction yesterday, there was a global risk-off trade combined with a flight to safety bid for safe-haven assets, and US treasuries tend to be the primary safe-haven asset.  In the last 30 minutes leading up to the auction itself, somebody took 10yr notes up from 99-28 all the way up to 100-02+ (to be fair, liquidity dries up in that time period).  Before this last minute run-up, 10yr notes had been stable around 99-28/29 for most of the morning.  Why the last minute uptrade into an auction?  That was fear.  Fear from a trader who had planned on going into the auction short...deciding to cover that short before the auction.  Why would a trader do this you ask?  Well, if the past, there have been a handful of occasions where strong demand for UST paper has caused the auctions to come thru...which cased massive violent short covering post-auction.  While nobody could have predicted whether this would or would not have happened yesterday, the result is very telling for us now.  The actual auction result came at an equivalent price of 99-29, so this last minute run-up turns out to have been unnecessary (though to be fair, not expensive enough to break the bank either).  From the 1pm price of 100-02 (the result of that run-up) the auction tailed to come at 99-29.  However, if we ignore that last-minute run-up, we would say that the auction came on-the-screws.  I believe this is the appropriate way to view yesterdays 10yr auction on-the-screws auction where the UST market had been rallying strong all day.  While this means there was not an insatiable demand for UST paper (that would have been a thru result), there was strong-enough demand to buy the paper at the avg price where most of the bonds had been traded pre-auction.  Or, in other words, the dealers bought their paper at about the same price where they collectively set their shorts.

So, to recap, yesterday's 10yr auction was a risk-off UST rally into the auction, followed by an on-the-screws result.  This means there is very healthy demand for UST duration, but not of the blood curdling fear based variety that would have cased a short covering result (indeed, almost everybody who tried the short setup lost money or was flat yesterday).

As i write this, the 10/30 curve (my favorite indicator of 30yr demand) is trading at the equiv of 119.5 (there is a 4bp roll from the new 10yr and the old add 4 to the today's section of the graph).  This is the steeps of the last 2 weeks (expected), but nothing too extravagant as the weekly range has been 114 --> 119.5  (that is slightly tighter range than normal for this curve).   With this months extra 2bln 30yr Fed buyback, i suppose its hard to expect much more steepening than this.  Darn that QE.

Volumes in the UST market are normal for this time of day (they are low for a 30yr auction day), and stocks have flat-lined since yesterdays sell-off, so no new real nuggets of information there yet.

Comparing UST with risk assets, relative value indicates that we are inline, both on a 1 and 6 month time scale.  UST has not cheapened vs stocks in the past week if you look at the 1 month chart and subtract 4bps from the 10yr yield to take into account the 4bp 10yr roll.

On the 6 month time scale, UST vs ES and EUR are also inline.

Last but certainly not least, Fed QE (also known as POMO).  There is a 5 bln 10yr Fed purchase coming up at 11am.  While this is a fraction of today's auction, greed still demands an attempt to sell some 10yr paper as high as possible to the Fed before the 1pm 30yr auction.  Clearly, the 30yr auction dominates in terms of duration, so i expect a touch more 10/30 steepening in the next few hours, but not so much in terms of an outright rally into the buyback like we normally play for to frontrun the Fed.

So, what is the conclusion for today's 30yr auction preview?   I don't foresee a thru auction, as we are trading near the highs of the last month in both price and spread.  There is a moderate curve concession, indicating some curve based demand (the flattener is a favorite trade coming out of this auction) but 4 bps of curve is small...12-20 bps of curve concession are need to be significant.  The outright demand will have to be based on short covering and overall UST demand.  I believe that yesterday fulfilled a large slug of the overall demand for UST paper, and so i don't see the fear based bid overwhelming the market.  There appears to be a bit of exhaustion in this market today.  We have not seen nearly enough short based setup for this auction to cover the duration, so if 1pm comes at current prices (30yr trading 98-12 as i write this), i expect a tail.  Market participants tend to have short memories, and the failure to make money from a short setup into yesterdays 10yr auction will have 2 effects.  For one portion of the market population, there is too much fear to try the short setup again today after its failure yesterday (these tend to be the weak hands) and they may lean towards sitting this auction out.  For the other half of the population, this confluence of events should provide the setup to try for a tail.

For the moment, that's my call...i expect a tail from this auction (or a selloff leading into it), and i want to exit the day with a 10/30 flattener.

more later on the blog as we approach 1pm....and trades will be posted to twitter if time permits.

govttrader out...

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