The short end of the Treasury market faces a challenge this week, with dealers scheduled to gulp down almost $50 billion of notes and bills before heading home for Thursday's turkey dinners.

Because of the holiday, the Treasury is squeezing three auctions into the first two days of the week. It will sell $23.6 billion of three-and six-month bills and $15 billion of two-year notes today, and $10.75 billion of five-year notes tomorrow.

Traders and analysts say the shortened week and the thin flows that are characteristic of trading around a holiday will make it more difficult to distribute the new securities and could generate additional price declines going into the auctions.

"My gut feeling is there will be a downward bias because of the supply, and because the area where it's coming, the short and intermediate area, has been most heavily hit," said Douglas Schindewolf, a money market economist at Smith Barney, Harris Upham.

Short-term prices have raced lower in recent weeks because stronger economic reports have convinced traders the Federal Reserve will hold monetary policy steady.

Some traders argued that short-term prices have cheapened up enough and the auctions can come without much more concession.

Late Friday, the two-year notes to be auctioned today were yielding 4.69% in when-issued trading and the five-year note to be sold tomorrow were bid at 6. 1 0%.

Traders said the two-year note's spread of 169 basis points over the funds rate looked attractive.

"At these levels, we've probably built in most of the uncertainties," a government coupon trader said. But Kathleen Camilli, chief economist at Maria Fiorini Ramirez Inc., said that 169-basis-point spread over funds is well below the 200-basis-point spread two-year notes were trading at last spring, when the economy seemed to be picking up steam and traders were worried the Fed might start to tighten policy.

Camilli said the short end might get some help ahead of the auctions, though, from the renewed tensions in European currency markets.

Sweden's decision Thursday to float its currency, the krona, led to speculation that weak currencies in the European monetary grid might be revalued over the weekend.

If a realignment creates turmoil in the foreign exchange markets, the dollar and dollar-denominated securities could benefit from a flight to quality, analysts said. Such a realignment would also bolster the German mark, clearing the way for German rate cuts, which would be another positive for the short end of the Treasury market.

The bond market gets a raft of numbers this week, including November consumer confidence, October durable goods and personal income, and the first revision of third-quarter gross domestic product.

Normally, the GDP revision would be the least interesting of this week's data, but analysts said traders might focus on the report if the already high third-quarter increase is revised higher, as many expect.

If the 2.7% gain reported last month is revised to a 3% increase, the market will take it "poorly," Camilli said.

Schindewolf expects third-quarter output to be revised to 3%, but said the bond market might find a silver lining in that particular cloud.

"To the extent that that suggests the recovery is a little more solidly grounded, that could reduce concerns about the need for fiscal stimulus, and that could be a plus." he said.

The coupon trader argued that the economic outlook had relatively little to do with day-to-day activity in the Treasury market right now. He said the market was waiting for definitive news on the labor market from the next employment report.

In the meantime, "900-pound gorillas" like the central banks and hedge funds are "muscling" the market," the trader said. "It's a very, very treacherous market, and we won't have any clear direction for several weeks or even until the end of the year."

Friday's Trading

Treasury prices ended narrowly mixed Friday as participants prepared for this week's auctions and tried to assess the impact of a possible realignment of the European monetary grid.

Late in the afternoon, the 30-year bond was up 1/8 to yield 7.53%, and note prices were slightly lower on the day.

Hopes that the dollar would benefit from a realignment of some currencies in the European Monetary System provided some support for short-term prices Friday, traders said.

At the same time, central banks were selling large quantities of Treasury bills and notes, possibly to provide themselves with ammunition for intervening in the foreign exchange markets, which pushed short-term prices lower.

The short end was also feeling the weight of this week's supply.

The long bond, which finished higher on the day, benefited from buying related to Friday's options expiration, traders said.

The December bond futures contract closed unchanged at 103 24/32.

In the cash market, the 7 5/8% 30-year bond was 6/32 higher, at 101-101 6/32, to yield 7.53%.

The 6 3/8% 10-year note fell 1/32 to 96 24/32-96 28/32, to yield 6.81%.

The three-year 5 1/8% note was down 3/32, at 99 25/32-99 27/32, to yield 5.18%.

In when-issued trading, the two-year notes to be auctioned today were yielding 4.69% and the five-year note to be sold tomorrow were bid at 6.10%.

Rates on Treasury bills were mixed, with the three-month bill up four basis points at 3.21%, the six-month bill up three basis points at 3.41% and the year bill unchanged at 3.61%.

Treasury Marlcet Yields

Prev. Prev.

Friday Week Month

3-Month Bill 3.26 3.13 2.99

6-Month Bill 3.49 3.43 3.27

1-Year Bill 3.74 3.65 3.51

2-Year Note 4.62 4.58 4.32

3-Year Note 5.18 5.14 4.86

5-Year Note 6.05 6.02 5.87

7-Year Note 6.45 6.44 6.39

10-Year Note 6.81 6.81 6.80

30-Year Bond 7.53 7.57 7.63

Source: Cantor, Fitzgerald/Telerate

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