10-Year Auction Thoughts

Includes: IEF
by: John Jansen

The US Treasury will offer a fresh batch of 10-year notes later today via a reopening of the outstanding 10-year note. At its current level of 2.75 percent, it is dead center in what many investors view as a wide 3 percent to 2.50 range. If you look at the 5s 10s 30s butterfly, the issue is also in the middle of the 10 to 35 range which has prevailed there. So, on the surface, the issue does not appear overly sexy.

However, I think that there are a host of reasons which make this issue appealing and will elicit demand at the 100PM bidding deadline. I think there is a reasonable short base in the market, and the JPM survey yesterday manifested that. Traders have an penchant to sell supply, and with 10s and 30s this week, I think traders have been comfortable pursuing that course. The issue had recovered following its post-labor hiccup back to 2.82, but I believe that in that recovery, much of it is day trading-types just passing confirms around to one another as one short covering trader lifts another establishing a short. So, I think that the auction today is a liquidity event which will allow shorts to surreptitiously cover.

There are other factors at work which favor the course of buying this auction. The tectonic plates which undergird the market are shifting. The world is a dangerous place, and investors are in search of some deep weeds (or maybe just weed) in which they can hunker down. The situation in the Ukraine has becalmed itself for the moment, but with the referendum planned in Crimea this weekend, that county’s woes should be the focus of increased attention as we go forward. China is another source of concern as its credit problems and the potential for an economic slowdown there roil commodity markets and equity markets.

In addition, there are investors in the long-end of the market who need duration. Pension funds and insurance companies are dip buyers in fixed income. They are not going away, and this would be an ideal time for them to add duration. Some spread product investors use the Treasury auction to get their duration, and then over time, they peel off the Treasury paper as they locate appropriate spread product.

There are two other factors which favor today’s auction. I noted earlier, the broad range is 3.00 to 3.50 on 10s. However, inside of that range, there is a tighter local range of approximately 2.80 to 2.60, and at 2.75, we are in the back-end of that range. Finally, 10-year Treasuries are trading about + 114 to Bunds and were at 116 earlier this week. Those are multi-year highs, and the last time the spread was out here was in 2005. I think this wide spread will motivate investors to flee Europe for the safe warm cocoon of the Treasury market.

The bottom line for me is, Don’t be wrong, get long!! I think if the environment does not change materially between now and 100PM, we will have a well-received auction today.