US Credit Mkt WkAhd:Traders Eye N.Korea; 2/5/7Y/QE Unwind Wrld

--Traders Await Expected FOMC Taper Start In October

By Sheila Mullan

     NEW YORK (MNI) - Traders in the U.S. Treasuries market will watch next week

to see how the bond market digests the 2/5/7-year note auction supply in the new

era of Quantitative Easing to start in October.

     The Federal Reserve will start its taper/Fed balance sheet reduction

program in October. The Fed will whittle down its huge $4.5 trillion Fed balance

sheet, which includes $4.2 trillion in Treasuries and Mortgage-Backed

Securities. The Fed had bought bonds to alleviate the market worries since the

financial crisis of 2008-2009.

     The Fed will let its Treasuries and MBS run off its portfolio, said

traders. Once tapering begins, the U.S. Treasury would have to figure out how to

slice its debt issuance to cope with such a runoff of Treasuries. Traders also

eyed a potential December 2017 rate hike, with months of inflation data ahead to

be interpreted by the Federal Reserve.

     Goldman Sachs analysts said the recent FOMC meeting "reaffirmed our

expectation of a December hike, to which we now assign a 70% probability, and a

faster pace of policy normalization in 2018 than discounted."

     Tom di Galoma, managing director of government trading and strategy at

Seaport Global Holdings, said he found it "extremely difficult to believe that

the Fed will raise rates three times in 2018 due the structural changes to the

inflation rate. It's my view that inflation will remain quite subdued due to

rapid innovation which in turn will not allow for an aggressive Fed tightening.

     "In fact, inflation will probably fall which will make it quite difficult

for any new Fed Chair to tighten monetary policy despite their willingness to,"

he added.

     Treasuries should continue to see foreign exchange-tied buying by black box

hedge funds, if the U.S. dollar weakens against the Japanese yen. And there will

be related reverse selling if the U.S. dollar firms up vs. the Japanese yen,

said traders.

     Black box funds bought Treasuries in the correlated trade Friday morning as

the Japanese yen rose vs. the U.S. dollar in the buy Treasuries/buy Japanese

yen/sell US dollar correlated trade, with the reverse happening as the dollar

rose later, traders said.

     "The algos have that relationship working, and they are using it right

now," said one trader. "But this does not make sense. It's the most asinine

trade I've ever seen: Japan is right next to North Korea," so to rush into the

Japanese yen as a safe-haven trade is risky, said the trader.

     But a different veteran trader said the dollar/yen/Treasuries trade is "the

only thing" going on as the "market is very quiet." The Treasuries "went up

overnight on those North Korea headlines" about the North Korea dictator Kim

Jung Un threatening to set off a hydrogen bomb, he added.

     The Treasuries gain caused "trading shorts" who set shorts after the FOMC

meeting and its December tighten hint, to cover Treasuries shorts positions into

the weekend, he added. He argued that buying the yen amid the North Korea

missile threat is not illogical, as "the yen is always a safe-haven" refuge.

     Some still expected at least mild safe-haven bid into the weekend/next week

on the lingering North Korea risk. Glen Capelo, head of rates at Academy

Securities, noted several reasons why Treasuries price action "turned" positive

"plus the stats favor a bounce. North Korea makes it difficult to want to be

short over the weekend."

     He noted the TY 10-year Treasury futures have "settled lower for 10

consecutive days," but managed to close higher Friday, smashing the losing

streak. "There has been only 3 occasions in 30 years where it has settled lower

for 9-plus consecutive days: 2011, 1994, and 1990 (at 11 times, the longest),"

he added.

     He added "North Korea is heating up once again" plus "all the new shorts"

since the FOMC meeting "are now under water." He advises on the TYZ7 10-year

futures that the 125-28 or 100-00 cash 10-year note price levels will "act like

upside pivots." He added "for confirmation, going through 126-00 TYZ7 and 100-06

10-years, brings in a wave of short-covering/buyers."

     Looking ahead, Credit Suisse economists eyed next week's economic data as

"PCE, Q2 GDP revisions, durable goods, consumer confidence, and new home sales

will be released." They projected Tuesday, US "consumer spending likely slowed

in August, with nominal growth declining to 0.2% MoM and real expenditure

contracting slightly. Core PCE prices should see their strongest monthly

inflation rate since January, rising 0.2% MoM. However, due to a strong base

effect, year-on-year core inflation should remain stable at 1.4%."

     Deutsche Bank economists said "market attention will pivot to prospects for

tax reform in the US. Since the beginning of the year, market participants have

steadily lowered expectations for broad-based tax reform."

     They said "to be sure, the legislative process itself and the time

constraints ahead of the 2018 midterms are challenging. However, there are

potential avenues for targeted reforms that if designed properly could be a

modest positive for GDP growth in the longer term.

     The US Treasury has a busy supply schedule next week: it will sell a $26

billion 2-year note auction at 1p.m. ET Tuesday Sept. 26, then $13B 2-year FRN

reopening Wednesday Sept. 27 and the $34 billion 5-year note auction also later

that day, then finally the $28 billion 7-year note auction Thursday, Sept. 28.

T-bill auctions include a $42 billion 13-week bill auction on Monday, Sept. 25

and $36 billion 26-week bill auction that day too.

     BA/ML economists noted "the supply of "safe" assets is no longer shrinking,

as QE expansion fades, foreign exchange reserves stabilize and budget deficits

rise." They add "contrary to popular belief, the trend in neutral real interest

rates has only a very loose relationship to trend growth."

     Traders expected some rate-lock hedging action next week into moderate US

high-grade corporate bond issuance.

-- Questions? sheila.mullan@marketnews.com 212-669-6432; story also

reflects contributions from Giovanny Guerrero of MNI/New York.

-- A calendar of market events (data, Fed speakers) is below:

Date/Time ET Prior Data/And MNI Econ Poll Median Estimates

---------------------------------------------------------------------

25-Sep 0830 NY Fed Dudley:"Workforce Development"in Syracuse, NY Q&A

25-Sep 1030 ** Sep Dallas Fed manufacturing index 17.0/--

25-Sep 1130 am ET US Tsy $42.0B 13-Week Bill auction

25-Sep 1130 am ET US Tsy $36.0B 26-Week Bill auction

25-Sep 1240 Chic Fed Evans: lunch Econ Club of Grand Rapids, MI Q&A.

25-Sep 1830 MinFed Kashkari:Eye of Hawk Twn Hall Evnt Grand Forks,ND Q/A

26-Sep 0830 ** Sep Philadelphia Fed Nonmfg Index 31.8/--

26-Sep 0855 ** 23-Sep Redbook retail sales m/m +0.1%/--%

26-Sep 0900 ** Jul Case-Shiller Home Price Index +0.7/--

26-Sep 0930 Clvld Fed Mester: Global Outlook: NABE Annual Mtg Clvld Q&A 

26-Sep 1000 *** Aug new home sales 0.571M/0.577M

26-Sep 1000 ** Sep Richmond Fed Mfg Index 14/--

26-Sep 1000 *** Sep Conference Board confidence 122.9/119.7

26-Sep 1030 ** Sep Dallas Fed services index 15.1/--

26-Sep 1030 Fed Gov Brainard: Fed Brd Conf: Labor Disparities Wash DC

26-Sep 1230 Atl Fed Bostic:Econ outlk/Mon policy Atlanta Press Club Q/A

26-Sep 1245 Fed Chr Yellen keynote address NABE Annual Mtg Cleveland Q/A

26-Sep 1300 pm ET US Tsy $26.0B 2-Year Notes auction

27-Sep 0700 ** 22-Sep MBA Mortgage Applications -9.7%/--%

27-Sep 0830 ** Aug durable goods new orders -6.8%/+0.7%

27-Sep 0830 ** Aug durable new orders ex transport 0.6%/+0.3

27-Sep 0915 MinFed Kashkari Welcome at Tribal Comm Higher Ed Views Minn

27-Sep 1000 * Aug bldg permits revision --/-- m

27-Sep 1000 ** Aug NAR pending home sales index 109.1/--

27-Sep 1030 ** 22-Sep crude oil stocks ex. SPR w/w +4.59M/-- m bbl

27-Sep 1130 am ET US Tsy $13.0B 2-Year FRN reopening auction

27-Sep 1300 pm ET US Tsy $34.0B 5-Year Notes auction

27-Sep 1330 StL Fed Bullard:Eco/mon pol:TrumanSt Univ Kirksville MO Q/A

27-Sep 1400 Fed Gov Brainard Bkg & Econ/Minority Bkrs Forum; KC Mo Q/A

27-Sep 1900 Boston Fed Rosengren speaks at NYU Money Marketeers NY Q/A

28-Sep 0830 ** 23-Sep Initial weekly jobless claims --K/280K

28-Sep 0830 *** Q2 GDP (3rd) 3.0%/3.1%

28-Sep 0830 *** Q2 GDP Price Index 1.0%/1.0%

28-Sep 0830 ** Aug advance goods trade gap -$65.1B/$-- b USD

28-Sep 0830 ** Aug advance wholesale inventories +0.6%/-- %

28-Sep 0830 ** Aug advance retail inventories -0.2%/-- %

28-Sep 0945 KC Fed George: Bkg & Econ/Minority Bkrs Forum KC Mo Q/A

28-Sep 0945 * 24-Sep Bloomberg comfort index --/--

28-Sep 1000 Fed VC Fischer on BOE Independence/Conf in Ldn UK Q/A

28-Sep 1030 ** 22-Sep natural gas stocks w/w --/-- Bcf

28-Sep 1100 ** Sep Kansas City Fed Mfg Index 16 --

28-Sep 1300 pm ET US Tsy $28.0B 7-Year Note auction

28-Sep 1500 * Aug farm prices -2.9%/--%

28-Sep 1630 ** 27-Sep Fed weekly securities holdings -- -- t USD

29-Sep 0830 ** Aug personal income 0.4%/0.2%

29-Sep 0830 ** Aug current dollar PCE 0.3%/0.1%

29-Sep 0830 ** Aug total PCE price index 0.1%/-- %

29-Sep 0830 ** Aug core PCE price index 0.1%/0.2%

29-Sep 0900 * Sep ISM-Milwaukee Mfg Index 55.41/--

29-Sep 0945 ** Sep MNI Chicago PMI 58.9/59.1

29-Sep 1000 *** Sep Michigan sentiment index (f) 95.3/95.2

29-Sep 1100 ** Q3 St. Louis Fed Real GDP Nowcast -- -- %

29-Sep 1100 Phil Fed Harker; FinTech Impact/Bks, Pol, Consumers Q/A

29-Sep 1115 ** Q3 NY Fed GDP Nowcast -- -- %

29-Sep 1200 ** 16/17 grain stocks -- --

--MNI Washington Bureau; tel: +1 202-371-2121; email: kevin.kastner@marketnews.com

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