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Negative TIPS hangover in Treasury Futures

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October 26th, 2010

Negative TIPS hangover in Treasury Futures
Treasury bond and notes suffered on Tuesday at the hands of "OK" economic data and follow through selling left over from yesterday's 5-year TIPS auction.  If you recall, the Treasury reopened 5-year note TIPS (Treasury Inflation Protected Securities) at a negative yield for the first time in history! 
TIPS have been in rally mode for some time and the buying has been exaggerated by speculation of the Fed's next round of quantitative easing, known by most as QE2.  Although investors have found comfort in the idea of fixed income backed by the credit worthiness of the government, it is clear they are also seeking some protection from inflation via TIPS.  In a roundabout way, those holding long Treasury note positions can hedge their bets through the purchase of TIPS.  Should inflation rear its ugly head, the TIPS "should" take some of the heat off price pressures felt in more traditional coupon securities.
The Federal Reserve implemented another phase of its POMO (permanent Open Market Operations) today.  Specifically, they purchased $2.5 billion worth of maturities ranging from 2011 through 2040.  The Fed's current tentative Treasury buyback schedule ends on November 8th but they are expected to announced a new round of purchases at next week's Fed meeting. 
Most are looking for the next round of buying to be about $500 billion in size,  but some estimates are calling for as much as $2 trillion.  Our guess is, the markets have likely priced in a half a trillion but if the Fed opts for the last bazooka, the markets might not be fully prepared. 
The correlation between the Yen and Treasuries held true during the session.  As we pointed out yesterday, the correlation coefficient between the Yen and the December 30-year bond futures is in the mid-90's.  If this correlation stands, it could weigh down the long bond a little more before a reversal can occur. 
We were looking for support to come in near 131, but noted a move to 130ish seemed somewhat likely.  Today's low of 130'26 may or may not have been the low of the move, unfortunately we won't know until after the fact.  However, we do feel like taking a bullish stance below 131 with the willingness to withstand a move to 130ish makes sense given the current environment. 
Our numbers in the note were 126 and the mid-125's.  Again, today's lows appear to be getting close to what could potentially become a reversal level.  If you are holding bearish positions, you would likely be best off locking in a profit.  If you are looking to get bullish "down here", this could be the time to cautiously begin dipping your toe in the water.
* Due to time constraints and our fiduciary duty to put clients first, the charts provided in this newsletter may not reflect the current session data.  However, market analysis and commentary does.  Charts provided by Track 'n Trade, Gecko software.
**Seasonality is already factored into current prices, any references to such does not indicate future market action.

Carley Garner
Senior Analyst / Commodity Broker
DeCarley Trading
Local : 702-947-0701
*Due to the volatile nature of the futures markets some information and charts in this report may not be timely.
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Disclosure: No personal positions