The long bond yesterday achieved a record low yield for the third time this week as a solid note auction and expectations for a strong bond sale propelled the market higher.

The 30-year bond ended yesterday's session up 1/4 point, to yield 6.42%, the lowest level in the 16 years the Treasury has held regular 30-year auctions.

The market continued to glide through the Treasury's quarterly refunding yesterday when stronger-than-expected demand emerged for the 10-year note auction. Traders thought the 10-year auction would create the most trouble for the market.

Solid bidding at the auction prompted a short-covering rally and forced a number of investors to unwind hedges from the mortgage and corporate markets. A modest bout of outright retail buying also helped the bond turn in another impressive performance.

Late afternoon rumors that bankers involved in restructuring Brazil's debt are considering a special issue of non-marketable, 30-year, zero-coupon Treasuries as part of the plan also helped the long end of the market. Talk was that the Treasury would sell the instruments at market rates.

The Treasury set a 5.75% coupon on $11.025 billion of 10-year notes that it auctioned at a 5.78% yield, or a price of 99.773. The bid cover ratio was a solid 3.25%.

The results were stronger than market expectations for a yield of 5.80% and added fuel to the recent rally.

"The 10-year was very strong and has given the market a lot of momentum," said Joseph Liro, chief economist at S.G. Warburg & Co. Liro said the usual pre-auction attempts to build more attractive yields into the market failed and had a positive effect on market psychology going into the bond sale.

In early trading yesterday, note and bond prices lost steam as dealers tried to cheapen the market ahead of the 10-year note auction. Recent price action had pushed yields lower and made coupons less attractive to dealers and retail investors.

"The first trade was to back rates on the 10-year note up to levels at which people felt comfortable bidding," one head trader said.

Traders said the 10-year notes suffered from indifference as investors set their minds on 30-year bonds and from the fact that the recent rally had brought the 10-year into unattractive territory.

But after the successful 10-year auction, "the market's performance was extraordinary," Liro said. "The bond has a life of its own right now."

The market's bullish tone remains firmly in place and the Treasury auction of $11 billion of bonds is expected to attract strong demand because of the market's appetite for longer-dated paper.

A $6 an ounce decline in gold prices and a nine-point drop in the Commodity Research Bureau Index lent further support to the long end of the market yesterday, though supply was the dominant factor behind the rise in prices.

Today's auction is the last leg of the quarterly refunding and market participants believe it will be the most successful sale, as strong retail, dealer, and foreign demand is expected to emerge. Late yesterday, dealers reported a healthy number of short positions set for the bond.

"The market is going into the auction with the supreme belief that the bond action will be a smashing success," said Anthony Karydakis, senior financial economist at First Chicago Corp.

Positive fundamental and technical factors continue to underpin the bond, which has outperformed the rest of the curve in recent sessions and brought about a flattening trend in the yield curve.

However, the latest series of inflation numbers could prove to be a wild card for the bond auction, traders said. While most economists on Wall Street are forecasting a marginal 0.1% increase in the producer price index, surprises have been known to happen.

"At these high price levels there is no tolerance for bad inflation news," Karydakis said. "The market will resume the rally when it gets further evidence that inflation is well-behaved."

In futures, the September contract ended up 5/32 to 116.08.

In the cash markets, the 4 1/4% two-year note was quoted late yesterday up 1/32 at 100.10-100.11 to yield 4.06%; the 5 1/4% five-year note ended up 1/32 at 100.16-100.18 to yield 5.12%; the 6 1/4% 10-year note was up 7/32 at 103.14-103.16 to yield 5.76%; and the 7 1/8% 30-year bond was up 1/4 at 109.05-109.07 to yield 6.42%.

In when-issued trading, the 30-year bond ended the session at 6.35%.

The three-month Treasury bill was down one basis point at 3.07%; the six-month bill was down two basis points at 3.23%; and the year bill was down one basis point at 3.47%.

PSA Sees Inflation at 3%

The Treasury Advisory Committee of the Public Securities Association said yesterday it is unlikely that inflation will dip below 3% anytime soon.

In its report to the secretary of the Treasury, the committee responded to the deals of the Treasury's third quarter refunding announcement on Aug. 2.

The committee said the Treasury may need to issue a cash management bill of $6 billion to be auctioned Sept. 2, to cope with a cash shortfall at that time.

The committee reaffirmed its belief that the quarterly refunding should remain a central focus of Treasury financing; that investors expect the Treasury to confirm in this refunding its commitment to issue $11 billion or more of long bonds on a semiannual basis; and that the 10-year note should be at $11 billion to affirm its new role as a global benchmark security and to signal that it will need to grow in size above present levels in the next quarterly refunding. Treasury Market Yields Prev. Prev. Wednesday Week Month3-Month Bill 3.07 3.13 3.066-Month Bill 3.23 3.30 3.211-Year Bill 3.47 3.54 3.372-Year Note 4.06 4.16 3.953-Year Note 4.45 4.46 4.265-Year Note 5.12 5.22 4.977-Year Note 5.39 5.51 5.3210-Year Note 5.76 5.87 5.7030-Year Bond 6.42 6.55 6.53Source: Cantor, Fitzgerald/Telerate

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