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12 DECEMBER 2012

• ‘How much and for how long, Mr Bernanke?’
• Trading ahead of the Italian job (new 3-year BTPs)
• UK domestic focus: labour market statistics

10-year UST futures are marginally firmer, this morning, following yesterday’s material sell-off and a decent $32bn auction of the new 3-year note. All this amid geopolitical tensions and advancing Asian equities, ahead of a session likely to be traded in anticipation of the Federal Reserve, with the policy decision announced at 17:30, the projections disclosed at 19:00 and Bernanke starting the press conference at 19:15 GMT.

Lloyds’ global economists anticipate an extension of the current round of asset purchases to longer-dated Treasuries at a rate of $40bn per month. While observers and markets have been preparing for such an action for some time, there might still be risks regarding the actual size of the monthly purchases, with amounts below $45bn (what is needed to ‘substitute’ the maturity extension program at the long end) that might be received as a disappointment. E

Even more market-moving potential than the size of purchases per se will be any (other) indication of the expected duration of the program, either liable to be interpreted by markets in calendar terms or framed in terms of more detailed macroeconomic conditions under which the FOMC will consider that an increase in monetary accommodation is not needed anymore.

Further Fed policy action seems to have been priced by markets to a good degree [2], also via a flattening of long-dated forwards, while an estimate for the 5-year term premium that was close to the lower end of the recent range and not far from the historical low reached in July.

It is interesting, though, to see how these movements went into a moderate reverse over the past few sessions (the 30-year yield traded below 2.75% on Dec 6th and has retraced above 2.84% since then).

Before the FOMC announcements we will have the reopening of the OTR 10-year note for $21bn, which will be followed by a $13bn reopening of the OTR bond tomorrow. The same set of auctions in early Nov, at fairly similar yield levels, saw mixed results.

The 3- and 10-year notes saw a low level of indirect bidding, but at aggressive prices, while the dealer bid remained weak. The last bond auction showed the best results of the lot, driven by a very strong and aggressive indirect bid (largest bid for more than one year).

While heavy supply will continue next week, and a $45bn FOMC decision might well induce some profit-taking and further Treasuries softness, core market may receive some support ahead of the launch, tomorrow, of the new 3-year Italian BTP (up to €3.5bn), the first primary market test for Italy after the official ‘comeback’ of Silvia Berlusconi in the political competition.

In the UK, labour statistics are expected to show a count rate of claimants of unemployment benefits of 5K in Nov. Headline earnings growth is also expected having accelerated to 2.0% in the 3-months to October – its highest since 11Q4.

UK gilt BEI seemed to have quickly found composure after the pension consultation news [4], possibly still helped by persistently high inflation [5] and favourable valuations [6,7], as well as yesterday’s nominal sell-off, ahead of tomorrow’s £1.1bn auction of the IL24s: the absolute valuation of this issue is not as cheap at on Dec 5th, but it has been cheapening over the last couple of session in real yield terms, while also cheapening against neighbors on a number of RV measures.

CFC extension out of IL22s into IL24s currently features an incremental seasonally-adjusted forward real yield of more than 60bp.

Read the full Lloyds Rates Strategy here.

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