The Day Ahead: Private Payrolls, Non-Manufacturing ISM, Treasury Refunding

Markets are calm in early trading following a massive flight to quality and equity sell-off on Tuesday. Treasuries weakened modestly overnight before rallying back to yesterday's best levels early this morning, while equities are finally pointing upwards after eight days of heavy losses.

The benchmark 10-year Treasury yield has retreated less than one basis point to 2.617% after tumbling 41 basis points since July 28 to a fresh 2011 low on Tuesday. Its yield has dropped almost an entire percentage point since mid-April when it was 3.59%, despite multiple warnings from all three rating agencies that Treasuries could be stripped of their AAA ratings.

"With the debt ceiling raised and a minimal effort at medium-term deficit reduction made, markets have turned their attention to the risk that this spring's U.S. economic soft patch is becoming entrenched.," said economists at BMO Capital Markets.

They noted the debt-ceiling debacle may have left lasting damage on consumer and business confidence, with the only clear winner being Treasuries.

The two-year note is also one basis point higher at 0.332% while the long bond is basically unchanged at 3.907%. The 30-year yield fell 17 basis points on Tuesday, breaking through the 4% barrier for the first time since early November.

Mortgages saw heavy buying yesterday as real money investors adjusted the duration of their portfolio to better reflect new cash-flow assumptions. Yield spreads tightened into the rally and held steady for most of the session before profit taking and rate locking was reported in the afternoon hours. Loan supply from originators was reported near $1.5bn on average as secondary departments reset hedges. The Fannie Mae 4.0 MBS coupon is bid +2/32 at 102-20.  The current coupon is outperforming benchmarks. MND has shifted to a 50/50 CC blend using 3.5s and 4.0 coupons but says flows into 3.5 coupons, including GNs, has been limited. In fact desks report an unwillingess of dealers to bid on 3.5 GN loan supply.

In equities, the S&P 500 looks to open 7.25 points higher at 1,254.50 and Dow futures are 45 points higher at 11,849. The previous eight sessions have brought the Dow 858 points lower, a loss of 6.74%. Year-to-date it is up 289 points, or 2.5%.

Light crude oil fell 0.82% overnight to $93.04, while gold prices rose 1.54% to a new all-time nominal high of $1,669.90.

Meantime, in the latest weekly survey from MBA, mortgage application jumped 7.1% as both purchases (+5.1%) and refinancings (+7.8%) moved up. 

"Factors such as negative equity and a weak job market continue to constrain borrowers," said Michael Fratantoni from MBA.

Key Events Today:

8:15 - The ADP Employment Report came in higher than anticipated in June as it reported the creation of 157,000 private jobs. That caused economists to revise their estimates for the nonfarm payrolls quite a bit higher - one, for instance, revised his forecast to 175k from 100k - thus making the shock of sluggish growth all the more shocking. The report is less likely to be influential this month, but even so, everyone looks at the number. The median estimate this month is 100k, with estimates from 60k 150k.

"Our forecast of a 135k increase in ADP's private employment is consistent with our 85k call for nonfarm payrolls," said economists at Nomura Global Economics after noting the differences between the two reports' methodologies. No more commentary was available.

9:00 -  Treasury will announce it's quarterly refunding size. This is a bit different than the regular old auction announcements that happen more frequently and thus may get a little more attention to any deviations from previously expected amounts. We'll get 3s, 10s, and 30s next week. Keep that in mind as it will serve as a roadblock toward further rallies in the week ahead.

10:00 - The ISM Non-Manufacturing Index, a nationwide measure of the services, construction, and financial sectors, is actually supposed to pick up the pace a bit in July. Economists are forecasting a 53.7 score, up a little from 53.3 in June but a slower pace than the 54.6 two months before. With two days before the monthly employment report, this report is likely to get quite a bit of scrutiny.

"After declining by 1.3 points in June to 53.3, we forecast a small rise in the non-manufacturing index to 53.7 in July," said economists at Nomura Global Economics. "Service sector job creation, which accounts for the lion's share of the nation's jobs, has slowed over the past few months so the employment index within July's survey will be particularly important."