Treasury just sold $32 billion 3-year notes.

The bid to cover ratio, a measure of auction demand, was 3.22 bids submitted for every 1 accepted by Treasury.  This is slightly above both the five and ten auction averages. Furthermore, a bid to cover ratio above 3 is always strong. 31.7% of the competitive bid was awarded at the auction high-yield of 1.298%, which was 1bp below the 1pm "When Issued" yield. Another sign of healthy demand.

Primary Dealers did the heavy lifting here, adding 53.3% of the competitive bid. Compare that to a 52.8% five auction average and 45.9% ten auction average.  This has turned into a trend as dealers  have been forced to take down larger shares of inventory over the past five fundraisers in the short end of the curve. We contend it is a factor of global inflation fears. Dealers are just picking up the slack of direct and indirect bidders who see inflationary risks eroding their cash flows on a 2-3 year timeline. Accordingly these accounts demand higher yields (lower prices) when underwriting Treasury debt issuances.  We might also call out the street as using the auction process to cover short positions and prepare for the next round of Fed QEII coupon purchases. This case can be made based on the uptick in dealer tenders over the past three auctions.

Directs took 12.3% of the competitive bid, which is close to recent averages. Directs upped their bids tendered by $3.2 billion in this auction, implying they were interested in adding inventory but only at a larger concession/cheaper price/higher yield.

With a 34.4% award, indirects were on the screws vs. the five auction average, but in 2011 have generally been less willing to support Treasury supply in the short end of the curve. See inflation premium comments above.

Plain and Simple: Based on a trend of increasing tenders, it seems like dealers are actively and aggressively seeking out debt inventory in the short end of the curve, as opposed to being forced to buy because other accounts are disinterested.  This represents short covering or an attempt to hoard inventory only to have the Fed lift it down the road.  Decent auction here. Not terrific but above average.

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Market Reaction....

FNCL 4.5s are off their intraday low prints but aren't getting much directional support from TSYs and swaps.  We need that directional support  if "rate sheet influential" MBS coupon prices are to make a sustained run higher today. Unfortunately, with $21billion 10s on the auction block tomorrow and an empty data calendar ahead...there just isn't much reason to get excited about buying bonds right now. So we "wait and see" if the flight to safety gains momentum or stalls out. Right now the trend in oil prices and stocks is our friend, but it's gonna take another push through 3.40% range resistance and a test of 3.31% in 10s before we see a significant improvement in loan pricing.  The MBS paper shuffle continues until then...it's a day trader's delight.

The 10-year TSY note is -9/32 at 100-20 yielding 3.55%, near the yield highs of the day. The FNCL 4.5 is -6/32 at 101-20. Current Coupon MBS are trading tighter on the spot vs. benchmarks as the yield curve steepens ever so slightly.