An unexpected drop in May home sales helped Treasury prices improve in lethargic pre-holiday trading Wednesday morning.

By the time automakers reported stronger-than-expected sales figures during the afternoon, the market was depopulated and prices managed to hold on to their morning gains, with the 30-year bond closing 1/4 point higher to yield 8.41%.

Housing and autos are the two sectors that usually lead the economy out of a recession. On the basis of Wednesday's evidence, cars are doing their part, but the housing industry seems to be losing steam.

Sales of new single-family homes fell 3.3% in May, when the consensus forecast had been for a 2% rise.

Not only were May sales much weaker than expected, but all of April's gains were wiped out. The Commerce Department said April sales fell 0.2%, rather than rising 1.2% as it reported last month.

As a result, May sales came in at a seasonally adjusted 474,000 annual rate, the lowest level since January's 414,000.

Analysts said rising mortgage rates and home prices may be to blame for the drop in home sales.

"During May we saw mortgage rates move up in response to the deterioration in the Treasury market," said William Sullivan, director of money market research at Dean Witter Reynolds Inc. "So housing affordability may have dropped for some prospective buyers."

Paul Kasriel, a monetary economist at Northern Trust, said the marked weakness in home sales in the South may be related to wet weather in May.

He added that new home prices may be coming under pressure because the spotted owl dispute has driven up the cost of lumber and because builders are having a hard time financing new construction.

Those factors could continue to slow home sales in the months ahead, Mr. Kasriel said.

Mr. Sullivan was also pessimistic about the outlook for housing. "The best-case scenario for housing is that it's leveling off and the more worrisome scenario is that we'll see renewed weakening," he said.

But the softness in the housing market need not trip up the economic recovery, Mr. Sullivan said. "You can make the argument that exports have replaced housing as a driving force and te prospects for exports are still favorable."

Treasury Market Yields

Prev. Prev.

Wednesday Week Month

3-Month Bill 5.71 5.71 5.77

6-Month Bill 5.92 5.99 5.96

1-Year Bill 6.36 6.32 6.25

2-Year Note 6.96 7.00 6.80

3-Year Note 7.34 7.39 7.22

4-Year Note 7.49 7.58 7.44

5-Year Note 7.91 7.98 7.83

7-Year Note 8.12 8.20 8.04

10-Year Note 8.23 8.32 8.17

20-Year Bond 8.41 8.51 8.38

30-Year Bond 8.41 8.50 8.38

Source: Cantor, Fitzgerald/Telerate

Mr. Kasriel said another possible explanation for the weak home sales was that consumers were too busy buying other things recently, including cars.

With most manufacturers reporting, MMS International estimated late-June car sales came in at a 7.4 million annual rate, up from the 6.5 million pace in mid-June.

That brings the sales rate for the month to 6.7 million, the most robust level since last October's 6.9 million.

Although sales are improving, most manufacturers are still reporting big drops from year-ago levels. For example, General Motors' sales were off 27.6&, Ford's sales were down 28.7%, and Chrysler's sales were off 24.9%. By contrast, Honda's sales came in unchanged.

But Treasury prices held firm. Traders said the market had a firm bid and they were seeing more activity than they expected. "Somebody wants to buy it," a note trader said.

At the short end, a little bit of flight-to-quality buying caused by the stock market's losses plus some reinvestment demand from the year bills maturing today helped bill prices.

The Treasury announced it will sell $9 billion of seven-year notes next Wednesday, a $500 million increase from April's seven-year auction. Late Wednesday, the when-issued seven-years were bid at 8.14%.

The September bond future contract closed 7/32 higher at 93 23/32.

In the cash market, the 30-year 8 1/8% bond was 7/32 higher, at 96 24/32-96 28/32, to yield 8.41%.

The 8% 10-year note rose 3/32, to 98 9/32-98 13/32, to yield 8.23%.

The three-year 7% note was up 1/32, at 99 2/32-99 4/32, to yield 7.34%.

Rates on Treasury bills were lower, with the three-month bill down one basis point at 5.56%, the six-month bill off four basis points at 5.68%, and the year bill two basis points lower at 6%.

Payrolls To Rise 5,000

This morning's June employment report will show a 5,000 rise in nonfarm payrolls and a 7.1% unemployment rate, according to 22 economists surveyed by The Bond Buyer.

That compares with May's 59,000 increase in payrolls and 6.9% unemployment rate.

The range of forecasts for June payrolls is unusually wide, going all the way from an 85,000 decrease to an 80,000 increase. Analysts said it is difficult to forecast employment in June, the month when students leave school and look for work.

They also said there was nothing unusual about payrolls and unemployment both showing increases. The unemployment rate is a lagging indicator and usually continues to rise in the early months of a recovery.

Discount Reports Big Loss

In another reminder of how difficult it can be to do business in the Treasury market, Discount Corporation of New York, a primary dealer in government securities, reported it lost a large sum trading for its own account at the May refunding.

Discount said it incurred an after-tax loss of $8.079 million, or 99 cents a share, for the three months ended June 30. That compares with a net profit of $4.436 million, or 55 cents a share, in the second quarter of 1990.

The "negative results were primarily caused by losses taken in Discount's proprietary trading account during the U.S. Treasury's May quarterly refunding," according to Ralph F. Peters, who was the firm's acting chairman at that time.

The news pushed Discount's stock down 1 5/8, to 10 1/2.

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