The OTR market doesn't necessarily tell as clear of a story at the moment as 10yr futures. The picture there is clear, as we see both days contain a swell of volume at the the lows of the day. FNCL 4.5's are at 101-29 currently and reprices for the worse have been seen. Volume has trailed off after the official 3pm close yet stocks dance around multi-year highs. 10's will be looking to break a pivot point at 3.416 tomorrow.

Interestingly enough, it was the same trendline we've been referencing this morning that ended up providing support for rapidly rising yields. It's been revisited several times thus far, but continues to hold. So despite the reprices for the worse, the bond market is taking steps to retrench itself. FNCL 4.5's are currently at 101-28+, a 2 tick loss since the FOMC announcement.

10's currently sit at 3.4264 after bouncing hard off 3.37. FNCL 4.5's are down to 101-28. Reprices for the worse are possible. 10yr yields reached almost 3.44 on the spike, making this an important level to watch to see if the range consolidates from here.

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.

Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.

FED SAYS ECONOMIC RECOVERY CONTINUING BUT AT RATE 'INSUFFICIENT TO BRING ABOUT A SIGNIFICANT IMPROVEMENT' IN LABOR MARKET // FED SAYS ALTHOUGH COMMODITY PRICES HAVE RISEN, LONGER TERM INFLATION EXPECTATIONS STABLE, UNDERLYING INFLATION TRENDING DOWN // FED REPEATS INTENDS TO PURCHASE $600 BLN OF LONGER-TERM TREASURIES BY END Q2 2011 // FED REPEATS TO KEEP RATES EXCEPTIONALLY LOW FOR AN EXTENDED PERIOD, KEEPS FED FUNDS RATE IN ZERO TO 0.25 PCT RANGE // FED SAYS GROWTH IN HOUSEHOLD SPENDING PICKED UP LATE LAST YEAR, STILL CONSTRAINED BY HIGH UNEMPLOYMENT // FED SAYS POLICY VOTE WAS UNANIMOUS // FED REPEATS WILL REGULARLY REVIEW PACE OF SECURITIES PURCHASES, OVERALL SIZE OF ASSET PURCHASE PROGRAM

If you blinked, you may have missed the market's reaction to today's auction. No question it was a good auction, and one that almost any other day, would result in bond yields being lower an hour later. But the actual manifestations seen in charts are almost imperceptible. This is what we mean by "MUTED." Things are so muted, in fact, that if you were to take the support line previously discussed (connect the prominent highs of the day), the auction reaction trade is basically contained by a resistance line running parallel to the support line beginning with the first low yields of the day just after 9am! What does that mean? It means that a much better than expected auction has resulted in yield movements that are within the same standard deviation as the rest of the morning! All eyes on FOMC! Don't let the rising yields freak you out or conclude the market makes no sense. The 5yr auction was a good thing in the sense it wasn't a bad thing. If FOMC is also "not a bad thing" for bonds, we'll get back a bit of positivity from the 5yr auction that might have otherwise been felt on a day where it was the star rather than a supporting actor.

The most refreshing observation we take away from this auction is the notable uptick of indirect bidder participation. After their dismal turnout at the 2 year note auction yesterday, this alleviates fears that overseas investors may be looking for a larger inflation premium in U.S. debt yields to compensate for currency appreciation and inflation in their own country. Indirect bidders took home 45% of the competitive bid. This is above average and much improved from the previous four 5-year note auctions. Dealers who seemed to be bidding more aggressively on this issue had a small award vs. an obvious increase in tenders (low hit rate). This is a positive as we do not want dealers adding more inventory than they expected. Direct bidders we close to average on all metrics. The bid to cover ratio was an above average 2.97 bids submitted for every 1 accepted by Treasury. The High Yield was 1.7bps below the 1pm When Issued yield, which is essentially the market's forward pricing mechanism for new issue Treasury securities. This is a sign of strong demand.

U.S. SELLS $35 BLN 5-YEAR NOTES AT HIGH YIELD 2.041 PCT, AWARDS 29.85 PCT OF BIDS AT HIGH /// U.S. 5-YEAR NOTES BID-TO-COVER RATIO 2.97, NON-COMP BIDS $61.11 MLN /// US TREASURY - PRIMARY DEALERS TAKE $15.88 BLN OF 5-YEAR NOTES SALE, INDIRECT $15.71 BLN

It's unfortunate that lenders may be forced to reprice for the worse this morning as we still know nothing about how things will shake out this afternoon. More importantly, even after the most recent backup in 10's to 3.41, this morning's trading action STILL says nothing beyond this afternoon's headliners. Pull up your short term 10yr chart and you'll see what I mean. There are two prominent highs in yield so far this morning, one at 8:30 and the other at 10:20. With your mind's eye, draw a straight line connecting the two and you'll get the the exact support level for this most recent bout of weakness. This is the "intraday trend" that we mentioned earlier when taken in conjunction with a similar trendline that can be drawn by connection the low yield marks so far today. And yes... it could be in the high 3.42's by the time FOMC hits (though any measure of unexpectedness in treasury auction results could throw this off a bit). What this should tell you is that the market is very non-committal, trading within the confines of the first two highs and lows it saw this morning, and in a predictably weaker fashion ahead of supply and headline risk. The moral of the story CONTINUES to be "don't let the rising rates freak you out." In an important way, this trading day still has yet to begin. That said, when benchmarks rise in this manner (regardless of the reason), and MBS prices fall, lenders may be forced to reprice for the worse, and with FNCL 4.5's now at 101-31, we're getting into that territory.

Jan 26 (Reuters) - Extensions of tax cuts that President Barack Obama and Congress enacted last month will help push up the U.S. budget deficit to $1.48 trillion this year, the Congressional Budget Office forecast on Wednesday. In August, before the Bush-era tax rates were extended, the CBO estimated the fiscal 2011 budget deficit would be $1.07 trillion. The forecast is part of a semi-annual economic review by the CBO, the non-partisan budget analyst for Congress. The CBO also said the U.S. economy will expand 3.1 percent this year and 2.8 percent in 2012, with real gross domestic product growing an average of 3.4 percent in 2013-2016. "Revenue growth will be restrained by the slow and tentative pace of the recovery and by the 2010 tax act," the CBO said.

In fact, the range has been tight enough this morning that it stands a reasonable chance of breaking soon. With the added perspective of recent highs and lows. It's quite interesting to note that if if the trends set in motion by the current highs and lows this morning were to be maintained, that 10yr yields would be right in the middle of the 3.42's come time for FOMC, essentially matching the highs of the week. Whether or not the market turns out to be that mechanical remains to be seen. We'd continue to lean on the fact that whatever actually happens BEFORE FOMC is relatively inconsequential compared to that which happens after. Bottom line is not to panic over potentially lower levels that might be seen later this morning. Until then, we'll let you know how the aforementioned intraday range is holding up. 10's currently at 3.395 and FNCL 4.5's remain at 102-02.