Good Morning.

U.S. Treasuries traded sideways early in the overnight session but cheapened after the German Bundesbank raised their 2010 growth outlook from +1.9% to +3.00 and UK Retail Sales beat economist expectations. Ahead of Jobless Claims, Leading Indicators, the second Federal Reserve Treasury coupon purchase operation, and another auction supply announcement, U.S. equity futures are retesting overhead resistance and benchmark interest rates are trending higher.

S&P 500 futures are +6.25 at 1093. The 2-year Treasury note is UNCH at 0.504% and the benchmark 10-year Treasury note is -0-08 at 99-20 yielding 2.666% (+2.9%). The 2s/10s curve is 2bps steeper at 216bps and swap spreads continue to creep wider. 

Coming off another day of heavy loan supply (originator selling), agency mortgage backed securities are outperforming their benchmark big brothers. The October FNCL 4.0 is -0-04 at 101-29 and the FNCL 4.5 is -0-04 at 103-19.  Current coupon yield spreads are tighter.

Key Events in the Day Ahead

8:30 ― Initial Jobless Claims have been higher than 460k for the past four weeks, including 484k in the first week of August ― the highest level since February. For the second week of August, economists polled by Reuters anticipate 476k new claims. The worse news is that economists don’t believe the data reflect seasonal distortions.

“This week’s initial jobless claims data is expected to remain high and highlight the ongoing weakness in the labor market,” said economists at BBVA. “The trend in claims leveled out after falling steadily from March 2009 through March 2010. However, data in recent weeks is at one of the highest levels since the beginning of 2010. These trends support our expectation of a sluggish job market recovery in 2H10.”

10:00 ― Leading Economic Indicators, a composite measure of economic data, is expected to return to positive in July after turning up negative for two of the previous three months. Before those three months, the LEI saw 12 consecutive gains. Economists polled by Reuters anticipate a 0.2% gain for last month, led in part by labor data.

“Even though claims have risen in recent weeks, the figure fell slightly in July compared to June,” said economists at BBVA, predicting no change in the month. “However, other components such as consumer expectations, manufacturers’ new orders and building permits could drag down the index. This expected result would support our expectation of a slower pace of growth in 3Q10.”

10:00 ― Growth in the Philly Fed Index has been modest in recent months after rapid advances earlier in the year. The mean estimate is a 7.0 score in August, with some economists predicting a decline of 6 points and others looking for a gain as high as 10 points. The July score was just +5.1, way below the +21.4 recorded two months before.

“Although a broad set of indicators points to some slowing in economic activity, we do not believe it has been as steep as suggested by recent results for this index,” said economists at Nomura. “We therefore forecast that the Philly Fed index bounced back to 9.0 in August. We believe the prices paid index component of this report will continue to soften, reflecting primarily weaker metals prices.”

11:00 ― Treasury announces the terms of debt auctions scheduled to take place next week.  The Treasury will sell 2-year notes, 5-year notes, 7-year notes, and a 30-year TIPS bond.

11:30 ― James Bullard, president of the St. Louis Fed, speaks on monetary policy and the economic outlook in Rogers, Arkansas.

1:00 ― Charles Evans, president of the Chicago Fed, holds a press lunch.