US Credit Mkt WkAhd: Traders Eye N.Korea,Fed,Inflatn,Vacations

-- Traders Ponder Fed/Inflation Interaction 

By Sheila Mullan

     NEW YORK (MNI) - Traders in the U.S. Treasuries market will be watching

different factors next week: monitoring the simmering North Korea/U.S. tensions

first and foremost, but also the thinking about the interaction between the

Federal Reserve and the low 0.1% rise the July Consumer Price Index.

     Treasuries receded briefly Friday off the highs of a Korea-inspired

safe-haven bid rally amid speculation about a Russia/Chinese "plan" to defuse

the U.S./North Korea tensions. The plan suggested would be that North Korea

stops its nuclear missile tests, while the U.S. and South Korea would halt their

large-scale military exercises, said news reports.

     But by Friday afternoon, the situation remained unsolved, and so U.S. and

European accounts covered Treasuries short positions, rather than leave

themselves exposed in case of a weekend military flare-up.

     However, Monday, should there be no weekend flare-ups, it's likely that the

Treasuries could decline a bit, as traders reverse some pre-weekend safe-haven

purchases.

     Traders will try to develop views on how softer than expected July CPI will

affect the Federal Reserve's near-term monetary policies. Traders seemed to

believe that it would not affect the Fed's expected September potential guidance

on its balance sheet rundown, but could potentially affect the December 2017

rate hike. However that is way off, with months of inflation data ahead.

     The Fed could unveil its balance sheet reduction strategy -- letting

Treasuries and/or MBS run off its portfolio -- at the September FOMC meeting for

an October start date, said traders. Treasury then would have to figure out how

to slice and dice its debt issuance to cope with such a runoff of Treasuries.

     SocGen economist Omair Sharif said July "headline and core CPI rates inched

up by 0.1%, below the consensus estimates but exactly in line with our forecast.

While the data was discouraging for Fed officials, we do not think this takes a

December hike off of the table just yet."

     Sharif added the August CPI report will be released on Sept. 14, just six

days ahead of the Sept. 20 FOMC. 

     JPM economist Michael Feroli concluded the "near-term Fed implications" of

the "subdued" July CPI "are probably nil: the FOMC has set a very low bar to

begin balance sheet normalization next month, and today's number shouldn't get

in the way of that move."

     "Further down the line, while we continue to look for another hike in

December, today's number increases the burden on the inflation data to start to

show some more life," he added.

     BA/ML analysts Ralf Preusser and Shyam Rajan said they are "bullish EUR

rates vs the U.S. The Eurodollar strip is now as flat as the Euribor strip.

Terminal rate pricing has converged. And the entire tightening in EUR rates vs.

the U.S. was driven by real rates. We believe the factors for a correction are

in place: monetary conditions in the EA (Euro Area) are now as tight as they

were pre-QE, while financial conditions in the U.S. keep improving: this creates

headwinds for the EA and tailwinds for the U.S."

     They added that "positioning is long US Treasuries vs Bunds. The Fed's

balance sheet runoff will require the private sector to significantly increase

sponsorship of the US Treasuries market."

     They said "next week's FOMC minutes should confirm the impending caps on

Fed reinvestments, as well as provide some guidance on how reinvestments above

the cap will evolve. Another wake-up call for the market could be the quarterly

refunding announcement which may indicate increasing US Treasury coupon supply:

the next policy statement is scheduled for Nov. 1. However, the headwinds

related to being past peak-QE may only build gradually."

     BA/ML analyst Mark Cabana said he believed that Treasury "will run out of

funding associated with the debt limit in the first half of October. According

to Treasury's July statement of the public debt, Treasury has used $310 billion

of its $376 billion in extraordinary measures or 82% of its total available

headroom. We expect that exhaustion of this headroom should result in Treasury

beginning bill supply cuts towards the end of August or early September, and

likely total between $100 and $150 billion."

     He added "once the debt limit is resolved, we expect a rapid increase in

bill offerings that could total upwards of $380-$400 billion. Treasury has

stated their intention to raise $501 billion through marketable borrowing in the

4Q, and it seems likely that Treasury will only be able to raise $100-$120

billion in coupons over this period, which means that the rest of the funding

shortfall would need to be made up through bills. This would represent one of

the largest Treasury bill supply builds in recent years."

     BA/ML's Cabana eyed the "market implications of the swings in bill supply"

around the debt limit, studying past episodes. He said "large" bill supply

"cuts" will mean "longer-dated bills and discos outperform, short-dated spreads

widen, and repo rates decline. Longer-dated bills & discos typically performed

best during supply cuts as shorter-dated bills have the most exposure to any

default risk. Repo rates also move lower but remain bounded by the Fed's ON RRP

and short-dated spreads show signs of relative Treasury richening. Three-month

LIBOR OIS narrowed during these periods though most of this appeared driven by

banks finding other sources of unsecured USD funding in the wake of money fund

reform."

     He added that a "large increase" in bill supply means "longer-dated

Treasury bill and agency cheapen, front end spreads narrow and repo moves

higher. Longer-dated bills were most impacted by the increased supply though

discos also cheapened modestly. Repo moved up in the Fed's tgt range and GCF

breached the Fed's IOER rate on occasion. Spreads also narrowed."

     TD analysts TD's Priya Misra, Gennadiy Goldberg and Cheng Chen said they

"remain short duration and positioned for 5s/30s flatteners as the market will

need to price in additional supply due to Fed portfolio runoff, which we expect

to be concentrated at the sub-5-year part of the curve."

     Meanwhile, on technicals, JPM analysts said the cash 5-year note yield

"probes the rich end of the 1.77-1.82% key resistance zone. Breaks through there

would whipsaw medium-term momentum models, derailing any bearish medium-term

technical setup that had developed with the late-Jun/early-Jul reversal to

higher yields, and turn our attention to next resistance parameters layered at

1.65-1.67%."

     Traders watched for any corporate rate-lock hedging action next week, in

case of heavy US high-grade corporate bond issuance.

     Finally, it is likely that black box hedge funds may still be buying

Treasuries if there is a weaker U.S. dollar/yen vs. selling Treasuries on a

firmer dollar/yen, said traders.

     After all these considerations, many traders are thinking about their

vacations, and how to rest up for a busy fall season.

     -- 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 

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

14-Aug 1100 ** Aug NY Fed expectations survey -- --

14-Aug 1130 am ET US Tsy $39.0B 13-Week Bill Auction

14-Aug 1130 am ET US Tsy $33.0B 26-Week Bill Auction

15-Aug 0830 *** Jul retail sales -0.2%/+0.3%

15-Aug 0830 *** Jul retail sales ex. motor vehicle -0.2%/+0.3%

15-Aug 0830 *** Jul retail sales ex. mtr veh, gas -0.1%/-- %

15-Aug 0830 ** Jul imports price index -0.2%/+0.2%

15-Aug 0830 ** Jul exports price index -0.2%/-- %

15-Aug 0830 ** Aug Empire Manufacturing Index 9.8/11.0

15-Aug 0855 ** 12-Aug Redbook retail sales m/m -0.3%/--%

15-Aug 1000 * Jun business inventories 0.3%/0.5%

15-Aug 1000 ** Aug NAHB home builder index 64/--

15-Aug 1130 am ET US Tsy $20.0B 52-Week Bill auction

15-Aug 1600 ** Jun net TICS flows $57.3B/$-- B USD

15-Aug 1600 ** Jun long term TICS flows $65.8B/$--B USD

16-Aug 0700 ** 11-Aug MBA Mortgage Applications 3.0%/--%

16-Aug 0830 *** Jul housing starts 1.215M/1.222M

16-Aug 0830 *** Jul building permits 1.275M/-- M

16-Aug 0830 ** Aug NY Fed Business Leaders Index -0.7/--

16-Aug 1000 ** Aug Atlanta Fed inflation 1.7%/-- %

16-Aug 1030 ** 11-Aug crude oil stocks ex. SPR w/w -6.5 -- m bbl

16-Aug 1400 Federal Reserve releases July 25-16 FOMC mtg minutes Wash.

17-Aug 0830 ** 12-Aug jobless claims --k/240K

17-Aug 0830 ** Aug Philadelphia Fed Mfg Index 19.5/19.4

17-Aug 0915 *** Jul industrial production 0.4%/0.3%

17-Aug 0915 *** Jul capacity utilization 76.6%/76.7%

17-Aug 0945 * 13-Aug Bloomberg comfort index --/--

17-Aug 1000 * Q2 e-commerce retail sales 4.1%/--%

17-Aug 1000 ** Jul leading indicators +0.6%/+0.3%

17-Aug 1030 ** 11-Aug natural gas stocks w/w --/-- Bcf

17-Aug 1300 Dall Fed Kaplan guided Q&A Lubbock, TX, Ch of Comm Q/A

17-Aug 1345 Minn. Fed Kashkari guided Q&A at Edina, Minn Rotary Q/A

17-Aug 1630 ** 16-Aug Fed weekly securities holdings --/-- t USD

18-Aug 1000 *** Aug Michigan sentiment index (p) 93.4/94.0

18-Aug 1000 * Jul BLS state payrolls 314.7K/-- K

18-Aug 1000 * Q2 Advance NSA Service Revenue --/--%

18-Aug 1015 Dall. Fed Kaplan guided Q&A at Dallas Cty Comm Coll conf Q/A

18-Aug 1100 ** Q3 St. Louis Fed Real GDP Nowcast --/-- %

18-Aug 1115 ** Q3 NY Fed GDP Nowcast --/-- %

--MNI New York Bureau; tel: +1 212-669-6432; email: sheila.mullan@marketnews.com

[TOPICS: M$U$$$,M$$FI$]