The Day Ahead: Low Volume Expected as US Debt Shines vs Europe

Key events overnight include an Italian 183 day bill auction stopping at 6.5%.  If only that were the exception vs the rule for the European periphery, things might not be so bleak.  The toxicity has clearly spread to Germany where spreads continue to gap out versus US Debt and credit-default-swaps on 5yr German debt reached a record high overnight.  Stocks are weaker, yet again, as indicated by S&P futures, now down to 1152, and MBS are modestly weaker this morning as well, though holding Wednesday's lows quite nicely.  

There's no economic data expected today and cash volume(as opposed to futures which are actually trading with decent volume due to their rollover process -- December contracts will soon be replaced by March) is quite low.  Here's this morning's update from MBS Live:

MBS, TSYs Weaker This Morning, But Stronger Too! 8:21AM

Although US Treasuries have been trading in generally weaker territory since 8pm last night, and although the day-over-day change shows 10yr yields just over 3bps higher, they're actually STRONGER this morning. How can that be? 

Fairly often, you'll see us mention MBS being a "spread product" trading versus benchmarks like Treasuries, but the latter also has spread considerations versus other sovereign debt, namely EU Benchmarks, aka German Bunds. When US 10yr Treasuries were around 2.06% on 11/10/11, German Bunds hit 1.686%. Advantage: EU... But after the Bund auction earlier this week garnered only 2/3rds of the bids needed to cover the auction, they've been in a death spiral, now trading at 2.245 vs US 10yr's at 1.92. Keep in mind that these two securities share an extremely high degree of positive correlation--more than Treasuries and MBS, or Treasury yields and stock prices by far. Over a 2 trading session period, this is the most the spread between the two has ever moved. The fact that US Treasuries are still in the low 1.9's is a positive indicator for the US Bond market. 

Elsewhere in the US bond market, the securities with which we are more keenly interested are slightly weaker as well, but with similar themes playing out. Case in point, like Treasuries, Production MBS are lower this morning, but also like Treasuries, they remain contained by 11/23 lows. Fannie 3.5's are currently 5 ticks off Wednesday's 5pm levels at 101-26. This level seems like it was a baseline for a lot of rate sheets on Wednesday, so pricing may not be a whole lot worse today, despite the red (provided that we don't leak any lower before sheets start coming out). 

There's no economic data on tap today and volumes are extremely light. Volatility is possible, but as we said 2 days ago, we wouldn't read much into trading levels until next week.

The clearest pictorial representation of the "weaker but still strong" phenomenon in Treasuries can be seen in the following chart which shows 10yr yields as somewhat higher than Wednesday's best levels, but remaining underneath the longer term sideways trend at the lower grey line, perhaps even using as a supportive pivot-point.