By Isobel Kennedy

NEW YORK, Nov 13 (MNI) – The Treasury market opened the new week in a
holding pattern awaiting developments on the U.S. fiscal cliff.

The 10-year Treasury note hit a intra-day low yield of 1.57% on Tuesday in
overseas trading after hitting an intra-day high yield of 1.64% last Friday. But
for much of Tuesday it hovered in the 1.59-1.60% in New York trading.

While concerns about growth in the U.S. and the crisis in Greece are the
big picture topics, there is no doubt that the U.S. fiscal cliff is the main
issue for the U.S. stock and bond markets.

While there have been hints of compromise from both the Republicans and the
Democrats over the last few days, people on Wall Street are afraid to get their
hopes up too high.

On Tuesday, the October NFIB Small Business Optimism Index rose 0.3 to 93.1
and but also reported that a record 23% were uncertain about whether business
conditions will be better or worse in six months.

The stakes are very high for the Treasury market, too.

If the fiscal cliff is averted, it could lift the veil of uncertainty that
is hampering business confidence and economic growth. If that happens, U.S. bond
yields are clearly too low.

If, on the other hand, the “playing nice rhetoric” does not translate into
compromise on both sides to balance revenue raising with spending cuts, Treasury
yields could fall further.

And the timing could not be worse because the U.S. Thanksgiving holiday is
just around the corner and year-end is rapidly approaching.

This is not the time of the year when real money investors want to take on
new positions or get rid of old positions.

This was perfectly clear in the agency mortgage-backed securities market on
Tuesday. Spreads on both low and high coupon MBS widened as real money sold into
the higher dollar prices generated by the Treasury rally and the Federal
Reserve’s ongoing QE3 MBS buying program.

At the same time, MBS traders do not want to warehouse new positions as
year end looms and the outlook for interest rates grows murky.

No one expects interest rates to rise sharply until the U.S. economy shows
better hopes for growth, but traders are also loathe to buy MBS if yields are
going to rise 20 bps or so.

So for now, both the Treasury and MBS markets will remain cautious, ready
to pounce in either direction as the need arises.

On the event fronts this week, President Barack Obama will be meeting with
business leaders this week and the Federal Reserve will release the minutes from
its October 23-24 meeting on Wednesday.

Also on Wednesday, retail sales will be released but it is unclear how much
of Hurricane Sandy will be captured in the report.

On Thursday, the New York Fed Empire and Philadelphia Fed surveys will be
released. On Friday, industrial production will come out.

The financial markets were heartened late last Friday when SIFMA released
the following statement in response to the Federal Reserve, the Federal Deposit
Insurance Corporation, and the Office of the Comptroller of the Currency
issuing a notice stating that the January 1, 2013 effective date of Basel III
capital rules would be pushed back.

“Regulators have appropriately acted to give the industry more time to
implement these new capital standards and ensure that each of their systems is
updated to comply with Basel III,” SIFMA said.

“We remain committed to working with the regulators to ensure compliance
with Basel III capital standards to ensure the safety and soundness of the
financial system while not constricting bank’s ability to lend, facilitate
capital formation, and significantly contribute to our economic recovery,” SIFMA
added.

On a final note, bond traders said Tuesday they were paying far more
attention to the widening scandal surrounding former CIA Director General David
Petraeus than they were to the political mumblings over the fiscal cliff.

Hey, it’s a lot more interesting and a lot easier to grasp!

NOTE: Talk From the Trenches is a daily compendium of chatter from Treasury
trading rooms, as well as some sister market trading rooms, and is offered as a
gauge of the mood in the financial markets. It is not necessarily hard, verified
news.

** MNI New York Newsroom: 212-669-6430 **

–email: ikennedy@mni-news.com

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