The Day Ahead: Do or Die Time for EU Illusion or More Cyprus Slide?

Today should be interesting to say the least.  As is frustratingly the case on days where the biggest potential market movement is reserved for European headlines that may or may not come, the key word in any realistic outlook is "potential."  There's an atypically potent confluence of events today that hasn't gotten nearly the attention it's deserved, both due to recent noise from Cyprus as well as the timing of the Good Friday market closure.

Because Friday is a market holiday in the US, today is 'month-end' for portfolio managers and is their last trading opportunity to ensure their portfolios line up with various indexes.  In addition to being 'month-end,' March has the added dimension of being 'quarter-end' (same story as month-end, but on a slightly grander scale).  Depending on how many of these trades have already been made, this can introduce phantom forces to the list of valid market movers.  

In other words, there can be a meaningful push on either side of the market for no readily apparent reason.  This usually manifests itself with extra buying (good for Treasuries, MBS), but there's some question as to how much of that has already been seen this week given that today's an early close.  The slate of economic data and events isn't insignificant either (GDP, Jobless Claims, Chicago PMI, 7yr Treasury Auction), and all must be squeezed in to fewer hours than normal.

The concerns for US markets would be sufficient, in and of themselves, to make for an interesting enough day (especially with stocks near all-time highs and many pundits calling for quarter-end to be the inflection point), but Europe is certainly in the mix, if not the most potent ingredient.  After more than a week of containment in a "Cyprus Slide," Treasuries finally broke out yesterday and moved immediately back down to the familiar "do or die."  Charts will help explain.  Here's the Cyprus Slide on it's own:

The next chart is exactly the same, just marked up differently.  Note the following:

1. The Italian election fallout caused Treasuries to traverse the entire "Cyprus Slide"

2. Treasuries didn't stop there and continued through to what we're calling the "Do or Die" range where 1.84 took on a roll as a line in the sand between a brave new world of higher rates and return of wholesale Eurodrama, dragging yields incessantly lower.

3. Strong domestic economic data and delays in the Italian political process allowed yields to get scary high in the yellow circle area

4. Then last week's late Sunday/early Monday Cyprus Surprise popped us back down to the "Cyprus Slide" range (the role of The Little Engine That Could will be played by the voice in the market's ear saying Cyprus isn't as big of a deal as Italy and Italy isn't back in the office yet.

5. The weight of EU risks got too big in Wednesday's wee hours as Italy barely covered a debt auction, rules of the game changed mid-stream for Cypriot haircuts, yet another EU official reiterated Cyprus as a template, and news about political developments in Italy started to trickle in with expectations for meatier bits today.

6. Where else to go but back to the do or die line?

Now would be a good time to mention that German Bunds are already at levels not seen since US 10yr yields were trading AROUND 1.50 per cent!!!  There's definitely a lot of of defense being played against the same sorts of EU risks that took us to those levels in mid-2012, but the repricing of QE timelines has taken it's toll, compounded by small but steady improvements in economic data.  If today brings more of the same, and if Italy tosses out a few reassuring headlines, no amount of month-end/quarter-end buying is going to save us from a hard bounce off 1.84 (which would very likely put a 102 handle back on Fannie 3.0 MBS).  If the tenor out of Europe is risky and domestic data disappoints, the move to 1.80 would be very quick with 1.75 a possibility ahead of next week's Employment data.