By Isobel Kennedy

NEW YORK, DEC 3 (MNI) – The Treasury market was quick to turn lower early
Monday and that should put some of the perpetual nervous nellies on notice.

The 10-year Treasury note hit a high yield of 1.656% early Monday morning
on a wide variety of positive developments. And while the lows did not hold, it
is proof that one of these days yields are going to rise and stay on a rising
trend.

The 10-year settled at 1.60% last Friday and were trading around 1.61% in
overseas trade Monday until a variety of factors caused yields to rise:

1) Spain officially requested aid for 4 of its banks

2) Greece said it would proceed with its debt buyback and Greek spreads
tightened nicely;

3) The November Market PMI came in at 52.8 vs. 51.0 in October;

4) The Chinese PMI came in at a 7-month high;

5) Some other U.S. data came in nicely and Ford auto sales were very
strong.

The one downer of the day was that the November ISM printed at 49,5 vs,
51,7 and that stopped the bleeding in Treasuries. The 10-year note returned to
1.625% awaiting further information.

But the truth of the matter is this: if the fiscal cliff is not reached and
if the U.S. economy is able to gain some traction next year with the uncertainty
of the cliff and the U.S. elections in the rear view mirror, stocks could bounce
nicely with Treasury yields also bouncing.

It is a big if, we know, but the markets cannot live on negative news
alone. And the Federal Reserve will – we have not idea when – have to start
removing some accommodation.

There was proof positive on Monday that bond traders and investors have
been lulled into a strong sense of complacency because of the many years of
market engineering by the Fed. They just assume more is on the way.

But St. Louise Fed President Bullard (non-voter) shook people up a little
bit when he suggested that by replacing Operation Twist on a 1:1 basis, the Fed
would be easing policy further instead of keeping it the same.

Operation Twist, which expires at the end of December, is the program where
the Fed buys about $45 billion in long-dated Treasuries each month with the
proceeds of selling a like amount of short-dated Treasuries.

At the Fed’s meeting next week, the market feels sure the Fed will address
this issue because it is the last meeting of the year. It also feels very
comfortable that the Fed will opt to buy $45 billion long-dated Treasuries (with
no sales attached) to replace this program.

While Bullard does not vote until next year, he shook the complacency a bit
by suggesting the Fed buy only $25 billion long-dated Treasuries each month.
Bullard says if this is not offset by any sales it is the equivalent of not
changing policy.

Intellectually, he is probably correct. But the markets know there is a big
difference between buying $45 billion long Treasuries each month and only buying
$25 billion long Treasuries each month.

By the way, Bullard said nothing about the Fed’s current QE3 program under
which the Fed is buying $40 billion agency mortgage-backed securities each
month. This buying program is currently open ended.

What the markets do not know for sure is what the Fed will say next week.
They also do not know if there will be a time frame attached to any replacement
of Operation Twist. If the time frame is too short or too iffy, the markets will
not like that.

November car sales came in around 11.6 million domestic units and Hurricane
Sandy definitely played a part.

“Replacement sales and also an aversion to used cars which may have been
flooded,” one of our readers in New York said.

And a reader in the Chicago area said he just leased a new Ford Explorer
last month, saying the “bells and whistles available are amazing.”

Ford said a 20,000 to 30,000 sales boost was seen from the storm.

Ford also said it plans to build 750,000 vehicles in the first quarter, up
11 percent (73,000 vehicles) from 2012’s first quarter. Fourth quarter
production of 725,000 vehicles is unchanged from previous guidance.

Also on the date front Monday, October construction spending rose 1.4% well
above the gain of 0.4% that was expected.

Stay tuned. The Republicans have just countered the Democrats tax/revenue
proposal. The games should begin again soon!

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 Bureau; tel: +1 212-669-6434; email: ikennedy@mni-news.com

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