The Day Ahead: EU Contagion, FOMC Minutes, MBS Roll

Concerns that Greece could see a "selective default" flattened the Treasury yield curve overnight as investors exchanged short-term paper for intermediate and long-term bonds. The latter have become particularly rich since since Friday's weak payrolls report. Equities, once again, are in a sea of red.

"Overnight trading volumes were huge in the 10-year Treasury futures contract as a flight to safety poured into the long-end of the yield curve," says MND's Adam Quinones. "Greek, Italian, Portuguese, and Spanish debt spreads all gapped wider to U.S. benchmarks last night. The dollar rallied heavily as the Euro broke key technical support at 1.417. And stocks around the world sold off between 1.25% and 3.06%".

The two-year Treasury yield is currently one asis points weaker at 0.367% in early trading but the 10-year yield is trading 2.7bps lower at 2.897% while the 30-year Treasury yield is 3.6bpss firmer at 4.174%. The Fannie Mae 4.0 MBS coupon is +2/32 at 101-02. Mortgages are clearly lagging benchmarks again today.

The S&P 500 is ready to open 5.00 points lower at 1,313.50 and the Dow looks to drop 23 points to 12,469.

"Selling activity intensified after the European Union Finance Ministers' meeting failed to come up with an answer on how to deal with Greece, and talk of a Greek default appears to be gaining traction, despite protests from the ECB," BMO said. "The Dutch FM said that as far as 'selective default' for Greece goes, 'it is not excluded anymore.' It also didn't help that IMF head Christine Lagarde said that 'We're not at the stage of discussion the conditions and terms and length and volume' of a 2nd bailout package.'"

Analysts at Nomura commented: "For the first time there has been explicit recognition that a solution for Greece is likely to need steps to 'reduce the cost of debt servicing and means to improve the debt sustainability of Greece.'"

The analysts said EU policymakers signaled an important change in their approach to the debt crisis but the market is looking for a more immediate response. Until they get one, the market is reverting to sell-mode.

"The immediate challenge facing policymakers is to end the disorderly market conditions in recent days, not least today," Nomura said. "It is clear that this sovereign crisis is no longer just about Greek solvency, and we think policymakers need to act much more quickly than they have been if the seriously adverse scenarios that we have also outlined are to be avoided."

Key Events Today:

8:30 - Expect the Trade Balance to narrow once again in May. Economists are projecting a $42.7 billion deficit this month, versus a $43.7 billion gap between exports and imports in April and a $46.8 billion gap in March. Higher gas prices are thought to have limited imports in the month, while exports should recover following a temporary disruption from the March earthquake in Japan.

"The export demand, falling oil prices, and slightly higher dollar should serve to decrease the trade balance, though the movement is unlikely to be very large," said economists at Janney Capital Markets. "At this point, however, foreign trade appears to be one of the stronger sources of economic growth for 2Q and is running roughly 8% ahead of 1Q results."

Janney noted that US exports to the rest of the world hit a record high $175.6 billion in April, reflecting global demand for US-produced capital goods coupled with an earthquake-driven slowdown of exports out of Japan."

2:00 - The FOMC Minutes from the June 21-22 meeting will be of more interest to historians than anyone toying with the markets. Comments in the monetary policy statement centered on the view that unemployment was improving and growth was picking up, observations that "will seem stale" now, according to economists at Nomura Global Economics.

"Chairman Bernanke expressed more anxiety in his press conference about 'longer-lived factors,' they noted. "The relatively weak economic data of late suggests that monetary policy will be on hold for even longer. We expect the minutes of the 21-22 June meeting to show the extent of policymakers' concerns about the recent weakness."

1:00 - Treasury auctions $32-billion 3-year notes

3:00 - Class A MBS coupons (Fannie and Freddie 30s) enter the settlement process also known as "The Roll".