Good Morning.

We begin the day with benchmark 10s +14/32 at 100-24 yielding 3.532%, 5.5bps lower vs. yesterday's going out marks, and the yield curve bull flattening before Treasury auctions $32 billion 3-year notes.  Overnight volume was strong with 250,000 10yr futures contracts trading hands as of 8AM. Also on the calendar are Import/Export Prices and the International Trade Balance at 830 followed by some hawkish rhetoric from the non-voting soon to be gone Kansas City Fed President Thomas Hoenig. Last but not least at 2pm we'll get the monthly Treasury budget statement.

The risk trade is off today after several bond supportive news prints flashed on trading screens in the overnight session. S&P futures are 7 points lower at 1312.50 and Dow futures are down 56 points at 12,265.  The front month light crude contract is -0.32% at 109.57. Gold is -0.34% at 1461.70. 

Here is a recap of overnight news events...

Japan raises nuclear crisis to same level as Chernobyl: (Reuters) - Japan put its nuclear calamity on a par with the world's worst nuclear disaster, Chernobyl, on Tuesday after new data showed that more radiation leaked from its earthquake-crippled power plant in the early days of the crisis than first thought. Japanese officials said it had taken time to measure radiation from the plant after it was smashed by March 11's massive quake and tsunami, and the upgrade in its severity rating to the highest level on a globally recognized scale did not mean the situation had suddenly become more critical. "The situation at the Fukushima Daiichi plant is slowly stabilizing, step by step, and the emission of radioactive substances is on a declining trend," Prime Minister Naoto Kan told a press briefing on Tuesday. Kan said he wanted to move from emergency response to long-term rebuilding.

U.K. Inflation Unexpectedly Slows: (Bloomberg) -- The U.K. pound slid to the weakest level in almost six months against the euro and gilts jumped as data showed inflation unexpectedly slowed, damping speculation the Bank of England will have to raise interest rates. Sterling fell to its lowest level in a week against the dollar. Consumer prices rose 4 percent from a year earlier after a 4.4 percent increase in February, the Office for National Statistics said in London. Economists surveyed by Bloomberg predicted the rate would remain unchanged. The yield on the two- year note tumbled 11 basis points, while short-sterling futures advanced as traders scaled back bets for higher borrowing costs.

Yellen sees no rush to start tightening credit: (AP) - The Federal Reserve's second-highest ranking official on Monday said the economy is not strong enough for the Fed to begin tightening credit, countering a vocal minority of members who argue the central bank's stimulus programs are contributing to higher inflation. Businesses will be limited in jacking up retail prices because consumers are still spending cautiously, she said. And workers don't have the power to demand big pay increases because the jobs market is healing only slowly, she added. Those forces should prevent inflation from taking off.

German Investor Confidence Drops More Than Estimated: (Bloomberg) - German investor confidence fell more than economists forecast in April after the European Central Bank raised interest rates to curb inflation. The ZEW Center for European Economic Research in Mannheim said its index of investor and analyst expectations, which aims to predict developments six months in advance, declined to 7.6 from 14.1 in March. Economists expected a drop to 11.3, according to the median of 36 estimates in a Bloomberg News survey. “A number of risk factors have come together to damp the mood a bit,” said Joerg Lueschow, an economist at WestLB in Dusseldorf. “Germany has also been in a powerful recovery for more than a year and a half -- that has to slow down sometime.”

Small Business Optimism Index Declines in April: (NFIB) - The Index of Small Business Optimism gave up 2.6 points in March, falling to 91.9. Four components rose or were unchanged, while six lost ground. The “hard” components of the Index (job creation, job openings, capital spending plans and inventory plans) added two points while the  “soft” components (the other six in the table above) gave up 31 points. Index was driven by weaker expectations for real sales gains and business
conditions and a marked deterioration in profit trends. The decline in the percent of owners expecting higher real sales and better business conditions in six months alone account for 76 percent of the decline in the

Mortgages performed well yesterday amidst anemic volumes. Activity was generally focused on last minute roll trades before the monthly Class A settlement process began.  Loan pricing will be better today as the May FNCL 4.5 MBS coupon is +10/32 at 101-07. Current coupon spreads are UNCH vs. the 10yr TSY note and slightly wider vs. both the 10yr interest rate swap and 5-year Treasury note.

Key Events in the Day Ahead...

8:30 - The monthly Trade Balance is anticipated to shrink in February after a significant widening to begin the year. The January trade deficit ballooned to $46.3 billion - the biggest shortfall since June - from $40.3 billion in December, as total imports jumped 5.2% versus a 2.7% climb in exports. Rising oil prices played some role, but imports of other items also expanded rapidly (auto parts: 14%, consumer goods: 2.2%).
The February deficit should narrow with exports outpacing imports, economists say. Forecasts look for a gap of $44 billion. The rise in oil prices should be offset by a drop in import volume, and automotive imports are anticipated to decline after two heavy months.

"The combination of the weak dollar (bolstering export competitiveness) and rising global demand should be the key factors contributing to the improvement," predict economists at TD Securities. "Exports should rise for the eighth straight month while imports should fall modestly. Rising energy prices, however, should push the petroleum deficit sharply higher and excluding petroleum the trade deficit is expected to improve.
In the coming months, with the weak dollar continuing to boost export activity, the deficit should ease further though this is likely to be offset by rising energy prices."

9:15  - Federal Reserve Bank of Kansas City President Thomas Hoenig participates in panel, "Too Big to Fail? How Best to Regulate and Structure Financial Institutions to Ensure Future Economic Prosperity" before the National Association of Attorneys General Presidential Initiative  Summit.

2:00 - The Tea Party won't be pleased with this one. The Treasury's Budget Statement for March is expected to print a monthly deficit of $190 billion, according to economists polled by Thomson Reuters. That figure is nearly triple the March 2010 deficit of $65.4 billion, and far bigger than the five-year March average of $98.6 billion. Adding it to the deficit in the first five months of this fiscal year, the total will be $822.3 billion. Not a good start to the era of fiscal constraint.

"Tax receipts from individuals (income and payroll taxes) were probably less than in March 2010 because of payroll tax cuts," said economists at Nomura Global Economics. "In addition, outlays in the same month of last year were much smaller than this year, reflecting a reduction in the projected cost of the Troubled Asset Relief Program (TARP)."

2:00 - The New York Fed releases an updated QEII Treasury operation schedule

2:45 - Federal Reserve Board Governor Daniel Tarullo testifies on "Derivatives Regulation" before the Senate Banking  Committee

2:55 - Federal Reserve Bank of Dallas President Richard Fisher moderates panel, "How Does An Economy Grow? Government Policy and the Private Sector" before "The 4% Project: Driving Economic Growth" event.

Treasury Auctions:
11:30 - 4-Week Bills
1:00 - 3-Year Notes