Risk Aversion requires lower US Yields

US treasury prices remain on the front foot with yields plummeting. The middle of the US curve has fallen the most in a week on concerns that Italy will join neighboring Greece in struggling to form a strong government to implement austerity measures following the resignation of Berlusconi. With two governless peripheries, domestic yields are exploding. The inverted Italian yield curve is an economic sign that a recession is near. Italian 10-year product has barreled through that psychological +7% level, a yield that that triggered a call for a helping hand from other struggling peripheries.

The lack of domestic data releases this week has investors focusing on “headline risk”. This has pushed US 10’s through the psychological +2% mark (+1.97%) while economic risk has been tossed to the wayside. Risk aversion trading strategies remain in vogue and one of the reasons why Tuesday’s US three-year auction went so well. The three-year notes attracted the highest demand on record, boosted by investors seeking a refuge from Europe’s sovereign debt problems. The biggest market concern is how well the remaining auctions will fare?

Tuesday was “strong”, but Wednesday’s was “tepid” to say the least. The $24b 10-year sale drew a yield of +2.03%, compared with a yield of +2.016% just before the sale. The bid-to-cover ratio was 2.64, the lowest in two-years, compared to 3.12 from the past eight auctions. Indirect bidders remain robust at +41.6% compared to +44.3% for the past eight sales. Direct bidders purchased +8.2% of the notes compared with an average of +11.5%.

Investors note that the Fed is having no problem finding demand for its short-term bonds as it focuses further out the curve. This is a sign that the strength in the economy seen last month may be ‘short’ lived. Growing demand for shorter-maturity suggests that investors remain concerned that EU sovereign debt crisis may worsen and this despite last month’s US indicators revealing something different.

The market will now focus on the last of this weeks US auctions, the +$16b long bond.

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