Monday, July 15, 2013

US Long End Auctions (10yr and 30yr) Post Mortem

Wednesday and Thursday of last week were the US 10yr and 30yr auctions.  These auctions (combined with the price action in the secondary market leading up to the auctions) are the best times to gauge demand for UST paper.

1st the 10yr:
Heading into the 1pm auction, the market for UST paper was weak.  The most recent comments out of the Fed indicated the FOMC was planning on tapering their bond purchases starting as soon as September.  The mkt grinded sideways to lower all morning.  The mkt went into the auction at the lows of the day (asof 1pm)....and the auction came at the market (0.1bp small of a tail lets call this on-the-screws).  The FOMC minutes (came out 1hour after the 10yr auction) indicated that some Fed Members wanted to taper QE back in June.  This surprised the mkt and the 10yr mkt traded lower to below the auction price by a few ticks on decent volume.

Then Bernanke spoke to an economic club, and around 4:45pm EST made comments that the recent labor market statistics, including the unemployment rate, under-represented the problems in the employment situation in the US.  Bernanke said that because of this, the Fed would remain accommodative for an extended period of time.  He didn't specifically clarify if this comment on "accommodation" was referring to the Fed Funds rate, or to QE.  The market knee-jerk reaction interpreted this comment as "Taper-OFF"(recall this was just 3 hours after the hawkish FOMC minutes)....and 10yr futures rallied  1 1/4 handles in a very illiquid session (from 125-05 to 126-15+).  This felt like another "game changer"  Many market strategists were unhappy that BB would make such comments when the mkt was for all intents..closed.

2nd the 30yr:
The price action for the 30yr bond auction the following day was interesting.  The 30y mkt almost retraced its entire BB spike from the prior day, for the setup going into the auction..the mkt was illiquid and low volume all day.  It seemed like the auction setup was the only trade occurring that day.  Again, going into the auction the mkt was trading at the lows of the day asof 1pm (recall, this is 18hrs after BB's comments the prior day).  This time, the auction came stronger and stopped short (came thru the 1pm price) by 1bp (about 5+ ticks on the 30yr).  The 30yr bond proceeded to rally 16 ticks from the auction into the close.  Many traders described this auction sarcastically as "couldn't see that coming."

In the 2 days since the 30yr auction, many strategists and Fed watchers have commented that the "Taper-OFF" reaction to BB's comments may have been "too artificial".  They point out that BB's comments regarding accommodation could just as easily be referring to the Fed Funds rate, and have no bearing on QE. (since traditionally, the Fed Funds rate was THE mechanism for accommodation).  BB must know this (he's not that clueless) many rates strategists describe his comments as an effort to talk the mkt "up" without needing to do very much.  The longevity of such verbal efforts seems to be decreasing.

The Fed and Fed reporters have stressed that they think they can "Taper" QE and have no impact on market interest rates.  The market has made an effort to say "incorrect."  While the Fed has explicitly stated that a reduction in QE could be followed by an increase in QE if they detect negative influences in the economy...the market just doesn't believe.  While its true the mkt is forward looking....they just aren't THAT forward looking.  The market sees any reduction in QE as a direct path to NO QE.

Nobody knows for sure if QE is actually helping main-street (arguments go both is usually the case in economics)...but we can say with confidence that QE is helping other asset classes such as the stock market and related interest rate markets (hello mortgages).

As i write this, the UST market is selling off and looks like it may "fill the gap" to BB's comments on Wednesday evening.  Regardless...the ultimate conclusion of the mkt thus far is one of confusion.  Will the fed Taper...or won't they.  Both the FOMC minutes, and the Fed Speak afterwards from various fed speakers have been contradictory.  Its clear there is a disagreement inside the Fed itself regarding what the best course of action is.

Over the past week, volumes in the US treasury market have been hovering below 70% of average.  There have not been large initiating trades one way or there other.  Perhaps this is due to the summer season surrounding July 4th (its gotten hot in NY...and many participants have gone on vacation).

I myself eagerly await the return of the large i can return to my usual tactic of following them (my most profitable trading strategy).  Until then, its probably gong to be a dicey market to trade.

good luck

-govt trader

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