Following the 10yr auction, FNCL 4.5's moved to 103-06 within about half an hour and haven't deviated from that level by more than a tick. That lack of price volatility is all it took for a good number of lenders to reprice for the better and we'd anticipate that it will be most lenders by the end of the day. 10yr notes have been similarly stable, trading within a bp of 3.16 most of the afternoon. Volume is much lower than earlier and continues to decrease into the after-hours session.

WASHINGTON, May 11 (Reuters) - A surge in income tax receipts helped cut the U.S. monthly budget deficit in half in April compared to a year ago, figures issued by the Treasury Department on Wednesday showed. The budget deficit came in at $40.5 billion in April, compared with an $82.7 billion shortfall in April 2010, the Treasury said. But the relatively favorable data didn't change the picture of an economy heading deeper in debt and just days away from a May 16 deadline for hitting a legally set ceiling on government borrowing. For the first seven months of fiscal 2011, which ends Sept. 30, the cumulative deficit swelled to $869.9 billion from $799.7 billion in the comparable year-earlier period. * APRIL BUDGET DEFICIT $40.49 BLN VERSUS $82.69 BLN IN APRIL 2010 * CUMULATIVE DEFICIT $869.9 BLN FOR FIRST 7 MONTHS OF FISCAL 2010 VS COMPARABLE PRIOR YEAR'S $799.7 BLN * INDIVIDUAL INCOME TAX RECEIPTS IN APRIL $155.56 BLN VS $107.31 BLN IN APRIL 2010

* EMPLOYMENT GROWTH LEVELS SO FAR THIS YEAR ENCOURAGING BUT WILL ONLY BRING DOWN JOBLESS RATE SLOWLY * HIGHER FOOD AND ENERGY PRICES HAVE PUSHED UP HEADLINE INFLATION, BUT IMPACT LIKELY TEMPORARY * SEES GROWTH THIS YEAR AND OVER NEXT COUPLE OF YEARS IN 3-4 PCT RANGE, RELATIVELY MODEST GIVEN DEPTH OF DOWNTURN * CADENCE OF U.S. RECOVERY HAS BEEN HALTING * IT COULD TAKE UP TO THREE YEARS TO GET EMPLOYMENT BACK TO PRE-RECESSION LEVELS * FED'S JOB IS TO ENSURE SHORT-RUN INCREASE IN INFLATION DOES NOT BECOME PERSISTENT * LONG-TERM MEASURES OF INFLATION EXPECTATIONS REASONABLY STABLE AT THE MOMENT * SEES DOWNSIDE RISKS TO GROWTH OUTLOOK FROM POSSIBLE FURTHER SPIKE IN OIL PRICES OR WEAKENING IN HOUSING * CONCERN OVER NATIONAL DEBT, DEFICIT CAN CONSTRAIN CONSUMER AND BUSINESS ACTIVITY, NEED PLAN TO ADDRESS IT * CAN'T PREDICT BOND MARKET MOVES, BUT SHOULD NOT ASSUME WE HAVE AN INDEFINITE PERIOD TO DEAL WITH FISCAL MATTERS * SAYS NOT GOING TO ANTICIPATE WHEN A PROCESS OF UNWINDING FED STIMULUS NEEDS TO BEGIN * THE WAY ECONOMY IS EVOLVING SUGGESTS THAT FURTHER STIMULUS OF ANY LARGE MAGNITUDE MAY NOT BE NECESSARY *EMPLOYMENT NUMBERS WOULD NEED TO SHOW SEVERAL MONTHS OF IMPROVING JOB CREATION FOR FED TO ABANDON PLEDGE TO KEEP RATES LOW FOR EXTENDED PERIOD * VERY HIGH BAR FOR FURTHER BOND BUYING AFTER CURRENT ROUND ENDS IN JUNE

With the 10yr Treasury Auction meeting with better-than-expected demand and yields, bond markets are rallying. 10's are down to 3.157 and FNCL 4.5's are up to 103-06. Reprices for the better are probable and if current trends hold steady, even widespread.

*FED'S PIANALTO SAYS EXPECTS US GROWTH TO CONTINUE AT GRADUAL PACE OVER NEXT FEW YEARS, AT JUST ABOVE 3 PCT A YEAR *PIANALTO - COULD TAKE ABOUT 5 YEARS FOR UNEMPLOYMENT RATE TO REACH 5.5 PCT TO 6 PCT *PIANALTO - CURRENT STANCE OF POLICY APPROPRIATE, FED WILL EVENTUALLY HAVE TO BECOME LESS ACCOMMODATIVE *PIANALTO - DOES NOT EXPECT INFLATION TO REMAIN ABOVE 2 PERCENT BEYOND THIS YEAR, DESPITE RECENT COMMODITY PRICE RISES *PIANALTO SAYS WITH NO PRESSURE TO RAISE WAGES, LITTLE PRESSURE TO RAISE PRICES FOR SERVICES *PIANALTO - INFLATION EXPECTATIONS HAVE BEEN STABLE, BUT WATCHING SITUATION CLOSELY

* in November, Kocherlakota described the prospects of a rate hike by saying the Fed was "willing to raise rates at the appropriate time." But over the past several months, that vague commitment has changed to specify "late 2011" as a target for hikes. Here are the highlights: FED'S KOCHERLAKOTA REPEATS VIEW FED SHOULD RAISE INTEREST RATES BY MODEST AMOUNT AT END OF 2011 *FED'S KOCHERLAKOTA SEES CORE PCE INFLATION RISING TO 1.5 PCT BY YEAR'S END *KOCHERLAKOTA SAYS EXPECTS JOBLESS RATE TO FALL TO 8 PCT TO 8.5 PCT BY END OF YEAR *KOCHERLAKOTA-IF INFLATION FORECAST HOLDS, WOULD RECOMMEND HALF-PERCENTAGE POINT FED FUNDS RATE HIKE *KOCHERLAKOTA-IF CORE PCE INFLATION RISES TO 1.8 PCT IN 2011, FED SHOULD RAISE RATES MORE AGGRESSIVELY *KOCHERLAKOTA-IF 2011 INFLATION FALLS RELATIVE TO 2010, DESIRABLE FOR FED TO MAKE FURTHER ASSET PURCHASES

Despite the aggressive rally over the past few weeks (which brings yields lower, making the auction more challenging), today's 10yr auction Bid-to-cover was 3.0, which although a bit lower than average, is healthy considering the recent shift lower in yields. Then there's the yield itself... With a high yield of 3.21 pct versus a when-issued yield of 3.23, the decent demand was seen for lower than anticipated yields. Indirects sponsored just under half the offering, no concerns there. The overall take-away is that the market is slightly more comfortable with newer, lower yields than expected. And that should be good for TSY yields through the day.

After rallying consistently for two weeks bonds have reached overbought status, making upcoming debt auctions and economic events that much more important in the process of confirming a shift "Down in Coupon". We view bonds as having transitioned from being generally resilient and bullish to generally in need of retracing toward higher yields if the longer term rally is to continue. That means that we're not feeling great about the prospects for floating over the next week to 15 days. This defensiveness/bearishness will remain in place until we see another round of short covering and the market illustrates a confirmed willingness to buy bonds in size. Several yield levels overhead (using 10's as a benchmark) are possible locations for this support, most notably, between 3.31 and 3.40. Believe it or not, that would still be in line with a long term bullish trend. But trying to divine the future isn't as important as simply getting defensive here unless something miraculous happens with today's 10yr auction. Either way, it would need to be bullish enough to get us decisively through 3.14, something we don't see as exceedingly likely unless said "miraculous" event transpires. Absence of the miraculous event would simply serve to reinforce the defensive stance, even if yields aren't immediately skyrocketing.