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(Bloomberg) -- Spanish and Italian bonds led a European rally ahead of ECB with buying predominantly seen during morning session. Bund futures bounced from the open but saw some selling in the afternoon; 10-year sector staying higher into the close.

• Spanish 10-year yields fall despite heightened rhetoric between Madrid and Barcelona, following decline last week
  • Spain and Italy 10y yields fall 4bps
  • Some selling seen in Italian inflation- linked bonds as investors make room for a new one in November, traders say
• Strong bias to be short rates into the ECB meeting, with Barclays, Deutsche Bank and JPMorgan all recommending short 10y Bund into ECB, while Citigroup and BNP also expect bund yields to head higher in the short term: MORE
• Bund futures, dip from near session highs after two futures block trades, which appear consistent with sales
• Click here for a spreadsheet heat map of euro-area govt bond curves and spreads

To contact the reporter on this story: John Ainger in London at jainger@bloomberg.net To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net Anil Varma

(Bloomberg) -- Two-year OIS/UST spreads look ~4bp wide to fair value based on three-month GC/OIS, primary dealer inventories of short-dated Treasury paper and bill supply, Citi strategist Ruslan Bikbov said in Oct. 20 note. 

• Other factors that point to tightening risks going into year- end:
  • Net bill supply may rise going into year-end (est. $115b), especially after the debt ceiling suspension ends Dec. 8, since Treasury will be able to raise its cash balance
  • G-SIB surcharge score on Dec. 31 should put pressure on bank balance sheets, and be exacerbated by the Fed’s recent proposal to include cleared derivative transactions on behalf of bank clients in the calculation
  • Fed’s reserves should decline by as much as $780b by end of 2018 as the runoff pace accelerates, which may translate into “structural cheapening” of GC repo by as much as ~10bp tightening in OIS/GC, a move that may not yet be fully priced in
  • There’s a risk of increased coupon supply at the November refunding announcement, although “this is not our base case view”
  • Expected decline in UST demand from foreign central banks
• Citi prefers expressing view in OIS/UST tighteners in cash as opposed to OIS/TU invoice spreads, since TU shorts “already may be crowded”

To contact the reporter on this story: Alexandra Harris in New York at aharris48@bloomberg.net To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net Greg Chang

(Bloomberg) -- Money funds may start increasing their repo allocations, as the U.S. Treasury is expected to slash near-term bill supply in order to draw down its cash balance to $70b by Dec. 8, the end of the debt ceiling suspension, JPMorgan strategists led by Alex Roever said in Oct. 20 note.

• Increased repo investment may keep overnight financing rates low in the near term and put “substantial widening pressure” on front-end Treasury/OIS spreads
• Treasury/OIS spreads should remain wide as long as Treasury “undertakes extraordinary actions”
• NOTE: Treasury’s cash balance $201b as of Oct. 19

To contact the reporter on this story: Alexandra Harris in New York at aharris48@bloomberg.net To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net Greg Chang

(Bloomberg) -- Bund futures bounce from the open as some traders suggest short covering demand; small selling seen into the rally, though flows light. Peripherals gains as investors turn more bullish with political risks seen fading, demand seen in both 10y Spain and Italy, as well as block buyer in BTP futures vs bunds.

• Strong bias to be short rates into the ECB meeting, with Barclays, Deutsche Bank and JPMorgan all recommending short 10y Bund into ECB, while Citigroup and BNP also expect Bund yields to head higher in the short term: MORE
• Cash-flow environment turns very positive over the next fortnight with supply light; France to repay EU32.8b in redemptions this week, plus EU14.9b in coupons; next week sees redemptions worth EU16.8b from Spain (Oct. 31) and EU15.7b from Italy (Nov. 1)
• Investors turn more bullish on peripherals; decent buying seen across 7-10y Italy, plus 2.5k block buy in BTP futures vs 2.1k bund; demand seen in 10y Spain as Catalonia elections also seen as positive: traders
  • Italian yields lower by 3-4bps across 5-30y sector, Spain lower by 2-3bps
• Bunds underpinned from the open, though fade from highs as stocks gain; option flows have been skewed toward downside in bunds, though some upside trading this morning with buyer of Bund Dec. 162/163 call spread vs selling 160 puts for 10k, paying 6.5 ticks, say traders
• Treasuries dip in European hours despite gains in bunds, focus on 2.4% in 10y which many strategists have highlighted as key support. In options, large buying Nov. TY 124.25 puts is seen with 23k bought at 6 ticks, strikes targets ~9bps increase in 10y yields
• German 10y yield -2bps at 0.44%; Dec. bund futures +19 ticks at 161.63
• Spain 10y yield -3bps at 1.64%, Italy -4bp at 2.01%
• NOTE: Excel heat map of euro-area govt bond curves and spreads here
• For overnight news and what to watch, see EU FX/Rates Daybook

To contact the reporter on this story: Stephen Spratt in Hong Kong at sspratt3@bloomberg.net To contact the editors responsible for this story: Tan Hwee Ann at hatan@bloomberg.net Scott Hamilton