Short Covering Follows Average 3-Year Note Auction. Reprice Risk Fading

Treasury just finished their first fundraiser of the week. $32 billion 3s  have been auctioned. The results were not encouraging but they also did little to dampen the mood in the market. Nonetheless, we still have to take down two more coupons auctions before concessionary price pressures are alleviated...thus it is not surprising to see a little more weakness following the release of average 3-year note auction results.

Auction demand as measured by the bid to cover ratio was 3.06 bids submitted for every 1 accepted by Treasury . This is slightly below both the five and ten auction averages but not poor enough to sound the alarm bells as any BTC ratio over 3 is seen as strong.

When judging demand based on the market's forward pricing mechanism, the 1pm "When Issued" yield was 1.1bps below the "high yield" generated in the auction. This implies buyers were more than willing to wait for the auction before opening their wallets. This illustrates a concessionary effort on behalf of debt investors/primary dealers. And even though they waited, buyers did eventually show up to support Treasury's fundraiser, albeit at cheaper prices and higher yields.

In terms of the buyer breakdown...

Dealers took down 44.4% of the competitive bid and were awarded 22.3% of what they bid on. Both metrics are close to average.

Direct bidders reduced their participation relative to the previous 3-year note auction but were still awarded a slightly above average 16.2% of the competitive bid and 39.4% of what they bid on.

Indirects took home a slightly above average 66.9% of the competitive bid and 55.6% of what the bid on. Again..this award is close to average.

Plain and Simple:  In terms of the non-dealer bid (directs and indirects), this is the third consecutive 3-year note auction where dealer participation has declined and bid side interest has increased. That is a positive as it implies less forced buying and more willing participation from real money buyers. However, when looking at the big picture, this was an average auction. Not much to be excited about,  not much to be worried about...

The post auction trade has seen two-way activity with short covering leading the charge for improvements in benchmark 10s. This is occurring with a modest uptick in volume but nothing substantial that might indicate a release of stored outright demand. In related markets we heard a huge sell ticket was written in S&Ps which led to a sizable downtrade in equities right as the auction results printed. Whether it is a legit trade or not, it is helping us out via reallocation trades/stock lever.

MBS have outperformed all morning but are now giving back some of those gains vs. Treasuries (spreads slightly wider after the auction). Still, positive price movements in TSYs have helped production MBS coupon prices rally from pre-auction intraday lows.

The chances you'll see more reprices for the worse are fading a bit, but we remain defensive of another round of short selling in advance of the 10yr note auction tomorrow. Also it is starting to snow in the DC metro area. The snow flakes are huge. Get ready for another foot of snow New York! I suppose that means we should take into consideration a winter storm related lack of liquidity in the bond market...which would explain why traders are squaring up positions after the auction (short covering = position squaring = getting flat). None of this behavior is indicative of a shift in economic outlooks or strategic biases. This is tactical positioning around auction supply. It's a trader's world, we're just living in it.