Yesterday's well-bid two-year note sale buoyed the Treasury market, with the 30-year bond ending 1/4 point higher to yield 8.12%.
Traders were nervous going into the auction because it was the first coupon sale held since the Treasury told Salomon it could bid only for itself, not for customers.
Some participants thought that with Salomon partly sidelined, and with Treasury traders worried about the Securities and Exchange Commission investigation into collusion at previous auctions, bidding for the two-years might be sloppy.
Traders said worries about the SEC investigation did cut down on the usual pre-auction chatter yesterday. "Dealers aren't talking to each other, and retail isn't talking to anybody," a note trader said.
But the auction results showed the situation had little effect on demand for the Treasury's paper.
The $12.5 billion of two-year notes came at an average yield of 6.46% and will bear a 6 3/8% coupon, down from the 6.94% average and 6 7/8% yield at the auction in July.
The news that really surprised traders was that 6.46% represented both the average yield and the highest yield accepted, in what is called a bullet bid. Traders expected some bids would be accepted at a higher yield of 6.47%.
"The auction went a lot better than expected," a government note trader said. "People expected some kind of tail and they didn't get it."
The results showed there was "more than adequate demand" for the notes, said William Sullivan, director of money market research at Dean Witter Reynolds Inc.
"The market realizes that even if there are some problems bidding on the issues, the notes represent fundamental value," Mr. Sullivan said. "I think a lot of retail investors stepped up to the plate and bid for today's auction."
"The two-year went surprisingly well, with a bullet bid at 6.46%," said Stuart Richardson, who manages PaineWebber's U.S. Government Income Fund. "It's probably largely in dealer hands and remains to be distributed, but with the fed funds rate at 5.50%, dealers have a very nice positive carry, so there'll be no urgency to unload these things."
Traders said the better-than-expected auction results inspired some retail buying of short-term paper in the secondary market late yesterday. That pushed the price of the new two-year notes up sufficiently to depress the yield to 6.40% late in the afternoon, down from the 6.46% auction average.
Traders said the successful two-year sale was a good omen for today's auction of $9.25 billion of five-year notes. The other selling point for the fives is their yield advantage over shorter notes.
"A three-year extension into five-year notes nets 99 basis points [in additional yield], which is a significant pickup," a coupon trader said.
The market ignored yesterday's economic reports on consumer confidence and the merchandise balance of trade.
The balance of trade improved to a $15.6 billion deficit in the second quarter, from the $18.4 billion gap in the first quarter. And the Conference Board reported that consumer confidence slipped to 76.3 in August, from the 77.7 reading in July.
Stephen Gallagher, an economist at Kidder, Peabody & Co., said the market paid little attention because the numbers were in line with expectations.
And he said the erosion in confidence was too small to be significant since it takes a large monthly move before confidence begins to have an effect on the economy.
The September bond future contract closed 7/32 higher at 97 9/32.
In the cash market, the 30-year 8 1/8% bond was 3/16 higher, at 99 28/32-100, to yield 8.12%.
The 7 7/8% 10-year note rose 3/16, to 99 28/32-100, to yield 7.87%.
The three-year 6 7/8% note was up 5/32, at 100 12/32-100 14/32, to yield 6.70%.
Rates on Treasury bills were lower, with the three-month bill down three basis points at 5.37%, the six-month bill off four basis points at 5.43%, and the year bill four basis points lower at 5.47%.
Group Buys Discount Stake
A group of investors including McFadden Brothers, a New York investment bank, has acquired more than 5% of the outstanding stock of Discount Corp. of N.Y., the group said in an SEC filing yesterday.
Discount Corp. is a primary dealer in U.S. government securities.
Robert Hart, a lawyer representing George McFadden, a partner in McFadden Brothers, said the group held 410,000 shares of Discount's stock, which were purchased for an average price of about $10.
Phebe Miller, Discount's general counsel, said the firm had no comment.
Discount's stock closed at 12 yesterday, up 3/4 on the day.