Treasury supply could send USD/JPY higher still

The Treasury is poised to sell another massive $118 billion in notes next week. These will come in the two-, five- and seven-year maturities. The risk is that we will see yet another back-up in Treasury yields (move higher), which could see USD/JPY push into some fresh nearby highs as we close out the year. 10-year Treasury yields have risen an impressive 55 basis points to trade above 3.75% in recent days. The rise has been two-pronged. The Fed's exit from the Treasury market, following their $300 billion in purchases, elicited a modest grind higher - but this was to some extent "baked in the cake". The larger factor seems to have been the exit of most of the large macro hedge funds, which had been very involved in the Treasury market all year. What this does is remove a huge source of demand even as supply remains at astronomical levels. This means bond prices can only go lower in the very short-term, pushing yields to fresh recent highs. What this means is that the risk that USD/JPY breaks above the much ballyhooed 92 barrier is relative high. The correlation between the pair and the US 10-year yield has been a very robust 87% in December and anyone watching these two closely on an intraday basis will tell you that is has pretty well become the same trade. The prospect of weaker than anticipated appetite in next week's note auctions should not be discounted and this should help put USD/JPY 92/93 in the crosshairs.