Will fundamentals make comeback next week?

By Emily Flitter

NEW YORK (Reuters) – Wall Street is divided over whether the coming week will see more flight-to-quality flows into U.S. Treasuries or whether fundamental concerns such as inflation expectations and supply worries will dominate again.

Treasury prices have benefited from continuing unrest in the Middle East and North Africa, where fighting between pro-democracy demonstrators and government forces has disrupted oil flows from Libya and threatens to destabilize Gulf countries such as Bahrain and Saudi Arabia.

Some analysts think the unrest will drive more foreign buyers to the U.S. Treasury Department’s auctions of $66 billion in new debt next week. But others say the threshold for safe-haven demand may already have been reached.

In a note to clients on Friday, George Goncalves, head of U.S. rates strategy at Nomura Securities in New York, said “March ‘madness’ may have started early this year, with the crisis in the Middle East pushing buyers into Treasuries over the past two weeks and pushing fundamentals violently aside.”

But he continued with a discussion on the possible tail risks to focusing on the Middle east, and said further safe-haven buying ahead of the auctions could make the Treasury’s new debt sales go poorly.

On the other side of the debate was Calvin Sullivan, chief fixed income strategist at Morgan Keegan in Memphis.

“I suspect that the auctions will go fairly well next week,” he said. “Between the three auctions the aggregate amount being auctioned is less than the previous rounds so they don’t represent a new test in the investment community’s appetite.”

“Demand is going to be strong, especially among foreign investors, because of what is taking place across the sea.”

Treasury is scheduled to sell three-year and 10-year notes and 30-year bonds on Tuesday, Wednesday and Thursday. There will be little in the way of domestic economic news to help traders set up for each auction.

The Federal Reserve Bank of New York will announce on Wednesday the Fed’s Treasury purchasing schedule for the remaining segment of the its $600 billion quantitative easing effort.

On Thursday, weekly jobless claims will offer their incremental view of the labor market, while retail sales on Friday will give investors an idea of the effects the recent spike in oil and gas prices is having on consumers.

In a note to clients on Friday, Ian Lyngen, senior government bond strategist at CRT Capital Group in Stamford, Connecticut identified meaningful demand for 10-year Treasury notes at a yield of 3.67 percent.

Lyngen said while recent Fed data on dealer positions showed primary dealers betting the heaviest on a rise in yields than at any time since late 2009, a decline in yields at the end of this week may have forced some dealers to abandon short positions.

“In light of the unrest contagion within the Arab nations,” he added, “it seems too early for the all-clear signal.”

(Editing by James Dalgleish)