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10-year T-note prices recover after reports of Chinese caution on U.S. Treasuries
30-year T-bond auction to yield near 2.90%
U.S. PPI report expected mixedUnemployment claims remain favorable
Canadian and Mexican currencies fall on report that Canadian officials increasingly fear Trump will pull the plug on NAFTA

10-year T-note prices recover after reports of Chinese caution on U.S. Treasuries -- The 10-year T-note yield on Wednesday initially ran up to a new 10-month high of 5.595% but then fell back to close the day just slightly higher by +0.4 bp at 2.557%. The 10-year yield on Wednesday's high was just 4.5 bp shy of the 3-1/4 year high of 2.64% posted in Dec 2016 in the wake of the Nov-2016 election.

The 10-year T-note yield early Wednesday moved sharply higher on a Bloomberg News report saying that senior Chinese officials, as part of their regular review of foreign-exchange holdings, recommended slowing or halting the purchase of Treasury securities. The report said it wasn't clear whether those recommendations have already been implemented or indeed would be implemented at all.

The idea that China might lighten up its Treasury holdings was somewhat alarming for a skittish Treasury market that is already facing (1) increased Treasury debt sales to fund a larger U.S. budget deficit, and (2) a Fed that is progressively reducing its Treasury purchases for its balance sheet. The latest data indicates that China in October owned $1.19 trillion worth of U.S. Treasury securities, which accounts for 18.7% of Treasury securities held by all foreigners. However, China is unlikely to make quick changes in its Treasury holdings and the fact remains that the U.S. Treasury market is the only market that is large enough to help absorb China's massive forex reserves of $3.1 trillion.

T-note prices were also hurt on Wednesday by a new 10-1/4 month high in the 10-year breakeven rate of 2.053%, which extended the 5-week upmove to 19 bp, although the rate fell back later in the day to close little changed. The higher breakeven rate was due in part to Wednesday's rally in Feb crude oil prices to a new 3-year nearest-futures high and the daily close of +$0.61 (+0.97%) at $63.57.

The 10-year T-note yield moved lower during mid-day, however, after strong demand emerged for the 10-year note auction, illustrating that the recent surge in yields has drawn out some buyers. The 10-year auction produced a strong bid cover ratio of 2.69, which was the highest since 2016 and was well above the 12-auction average of 2.44. In addition, foreign entities were strong buyers with indirect bidders taking a hefty 71.4% of the auction, well above the 12-auction average of 63.8%.

30-year T-bond auction to yield near 2.90% -- The Treasury today will sell $12 billion of 30-year T-bonds in the second and final reopening of the 2-3/4% bond of Nov 2047, which the Treasury first sold in November. Today's 30-year T-bond issue was trading at 2.90% in when-issued trading late yesterday afternoon. That translates to an inflation-adjusted yield of 0.84% against the current 30-year breakeven inflation expectations rate of 2.06%.

The 12-auction averages for the 30-year are as follows: 2.31 bid cover ratio, $6 million in non-competitive bids to mostly retail investors, 5.6 bp tail to the median yield, 32.8 bp tail to the low yield, and 36% taken at the high yield. The 30-year is of average popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 62.9% of the last twelve 30-year T-bond auctions, which exactly matches the 62.9% average for all recent coupon auctions.

U.S. PPI report expected mixed -- The market consensus is for today's Dec final-demand PPI to ease slightly to +3.0% y/y from Nov's +3.1%, but for the core PPI to strengthen slightly to +2.5% y/y from Nov's +2.4% y/y. The markets will be carefully watching the Dec inflation data to see if it starts to catch up with the increased market expectations for inflation that have been reflected in the rising Treasury breakeven rates.

nemployment claims remain favorable -- The market consensus is for today's initial unemployment claims report to show a -5,000 decline to 245,000 (after last week's +3,000 to 250,000) and for continuing claims to show a +6,000 increase to 1.920 million (after last week's -37,000 to 1.914 million). The claims data remains in generally strong shape, but is a little elevated at present due to the holidays. Initial claims are +27,000 above October's 45-year low of 223,000, while continuing claims are +46,000 above November's 44-year low of 1.868 million.

Canadian and Mexican currencies fall on report that Canadian officials increasingly fear Trump will pull the plug on NAFTA -- The Canadian dollar on Wednesday fell by -0.7% and the Mexican peso fell by -0.3% after Reuters reported that Canadian officials are increasingly convinced that President Trump will announce that the U.S. will withdraw from NAFTA. The report noted that such an announcement could be an effective negotiating tactic since Canada and Mexico would then have only 6 months to reach an agreement before the U.S. would actually be out of the NAFTA agreement.

The 6th of 7 NAFTA negotiating rounds will be held in Montreal on Jan 23-28. The NAFTA talks are scheduled to wrap up by March. President Trump is reportedly impatient that Canada and Mexico are resisting his administration's aggressive demands for U.S. content requirements, a sunset clause, and ending the Chapter 19 dispute mechanism.

Railroad and auto stocks also fell sharply on Wednesday on that Reuters report since those sectors would be hard hit if NAFTA is canceled. Canadian Pacific Railroad fell by -3.1% and Kansas City Southern fell by -3.6%. GM fell -2.4%, while auto-parts makers Lear fell -3.6% and Magna International fell -4.0%. The Canadian dollar fell against the U.S. dollar since increased NAFTA risks reduce the possibility of a near-term Bank of Canada rate hike.

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