Treasuries Soar at Close

Treasuries advanced in the wake of the FOMC's deflation warning, and should extend gains after Thursday's 10-year auction

Treasuries extended their lead Wednesday, the day after the Fed refocused attention on deflation risks. While attention was still drawn to supply, in contrast to the 3-year auction the smaller 5-year note sale was readily mopped up in the wake of the Fed reverting to a weaker bias. Activity was unusually heavy in the outperforming belly of the curve thanks to corporate and sovereign supply in that area, which encouraged domestic and foreign demand. Modest mortgage-related buying was reported and a Bank of Japan bid on cash 5-year notes was also rumored.

Today's 5-year auction was better than expected and Thursday's 10yr auction should do well also thanks to scarce off the run supply in a 10-year duration. The economic calendar is free of market moving data Thursday, so the market will focus on a dearth of Fed speakers and the 10-year auction. The market should extend higher Thursday but follow-thru gains should be limited.

In terms of data, the inventory/sales plunged to a record low to 1.21, as companies continued to tighten their belts. The MBA mortgage index surged 18.6%, helped by fresh declines in mortgage rates. Consumer credit increased by $900 million. General Motors Acceptance Corp. ($1 billion 5-year notes) and General Electric Capital Corp. ($4 billion floating rate notes) priced deals that kept the 5-year sector busy, and may have helped swap spreads tighten further.

The December bond closed up 1-6/32 at 115-29, while the 2-year note and 30-year bond spread tightened 6 basis points to +326 basis points amid hopes of future Fed operations moving down the curve, which also helped the belly outperform. The dollar recovered somewhat against the euro, but slid further against the yen, raising the specter of BoJ intervention.

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