Wednesday, February 13, 2013

UST 10yr Auction Preview

Today's 24bln 10yr auction will be an interesting event in the treasury market.  Normally, issues being auctioned have both a curve and outright concession going into the auction (market participants sell the on-the-run issue to be auctioned in the secondary market, and cover that short in the auction).  On the margin, this has not happened heading into today's 10yr auction.  In fact, 10yr notes have richened as the setup for this auction has progressed.  This makes sense from an RV perspective (cash 10yr notes are very cheap on the 7-10-30 fly, so RV traders should be buying them vs 7's and 30's). Normally this RV trading behavior would take place AFTER / DURING the auction, rather than before, so the only concession we have going into today's auction is outright.  The treasury market has traded lower consistently over the past 3 days, and each time the selling was both auction setup related, as well as induced by the grinding higher nature of the Stock Market  (note - ES has continued to grind higher while consistently respecting its 3 month channel).  The bonds vs stocks model has been fairly range-bound...tending to bounce off any richening moments (my model now reads 10yr notes are 11bps cheap vs ES on the 7 month timeframe...and only 1 bp cheap on the 2 month).  I would read the outright concession on the 10yr note at about 5 basis points (would be 6-7 bps without the RV fly traders getting in the way).   With ES looking to stabilize around 1516-1518, it looks like the treasury market doesn't need to worry about an ES selloff in the next 30 minutes to create panic short covering.  The short base for the auction seems fairly well set, and i'd estimate the avg price of the short base to be around 131-17 in ZN....or 97-30 on cash 10yr notes.  So long as we stay below there (99% chance by the looks of it) this auction should go off without a hitch.  The tail / thru prediction for this auction is less certain.  We are 7 ticks off the low in cash 10yr any tail would probably come somewhere between here (96-20+) and there.  On the flip side, strong RV demand adds another set of auction buyers to consider.  As i've mentioned previously about before new 10yr note and 30yr bond auctions, over the past 3 years every new 30yr bond auction has seen rallies post auction 100% of the time.  Given that UST are trading on the cheaper side of the stocks vs bonds relationship, and we have seen "enough" of an outright concession...i don't see any reason for this cycle to be any different.  Dealers most likely want to come out of this auction long 10yr (both outright and on the curve).  I plan on using today to put on 1 unit of 10/30 steepener for the next 12-24 hours...and will look to add if we see more flattening after the auction.  I want to come out of the 30yr auction tomorrow long and in a 10/30 flattener...but we will have to see what the price action allows.

If today was the 30yr auction...i would be all bulled up to buy the auction and come out long given the price action.  Perhaps i'm not alone in that thinking..which will gravitate the auction to come on the screws @ 2.04

---In summary---

-5bp outright concession in place
-UST are 5-10 bps cheap vs stocks

-no curve concession
-US stocks have been grinding higher showing no signs of topping

I don't expect a tail.  Most likely we come on the screws to small thru.  I'm now in buy dips mode for UST...and i want to put on a 10/30 steepener...hopefully the price action post-auction allows that.

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