Short-term note prices led the Treasury market higher yesterday, fueled by a combination of retail buying and professional short covering.

The strength at the short end came as a surprise to traders, who thought short-term prices would remain under pressure ahead of next week's auctions of two- and five-year notes.

Late yesterday, note prices were up 1/8 to 3/8 point, while the 30-year bond was up 1/8, to yield 7.42%.

"We've seen the broadest-based buying out to five years that we've seen in over a year." the head of a government trading desk said.

Traders said the buying came from municipal governments that needed to defease refinancings, from foreign central banks, and from portfolio managers who had let cash build up.

Once short-term prices started to improve, the gains set off short covering that extended the rally.

Many participants have been betting on a flatter yield curve by setting up short positions at the front end and buying long-term paper outright.

Some of those people got uncomfortable yesterday and started to take off their flattening trades by buying short-term paper and selling long-term securities, traders said.

"Everybody and his kid sister is short the curve." the desk head said. "The market's just sold out temporarily and now you have the yield curve guys being squeezed."

A bond trader said the weakness at the long end was mostly due to flattening trades being taken off, but was exacerbated by Tuesday's $1 billion issue of Tennessee Valley Authority 30-year bonds. The TVA issue reportedly has not been selling too well and the trader said underwriters have hedged by selling long-term Treasuries.

The decline in the stock market also helped short-term Treasury prices, traders said, with the Dow Jones industrial average closing 29.18 points lower at 3,255.18. The bond trader said short-term prices were also aided by remarks by President-elect Bill Clinton this week that suggested he would put pressure on the Fed to avert any tightening in monetary policy.

Traders said yesterday's economic news was mixed and did not have much impact on bond prices.

"It all comes down to technical," the desk head said. "If the Street is short, you can get the greatest numbers for the economy on the face of the earth and the market will hold in or trade higher."

The indicators included an expected 1.5% increase in November housing starts, to an annual rate of 1.24 million units, and a 0.4% increase in November industrial production, which fell short of the 0.6% gain economists predicted.

Treasury traders liked the news that permits for new construction, which are seen as an indication of future activity, fell 1.5% in November.

Analysts said the reports were encouraging.

"The industrial production number was a little stronger than the housing report, but both are heading in the direction of moderate improvement in the economy," said Brian Keyser, an economist at CRT Government Securities.

He said November output was better than the report's 0.4% gain suggested because a 0.6% drop in utility output, which fluctuates with the weather, had offset good gains in manufacturing and mining production.

The short end had such a firm tone yesterday, it held its gains even when the Treasury announced bigger-than-expected increases in next week's two- and five-year note sales.

The Treasury said it will sell $15.5 billion of two-year notes Tuesday, up $500 million from the amount it sold in November, and $11.25 billion of five-year notes Wednesday, which is also up $500 million from last month's auction.

Economists expected some increase in the issues' sizes, but few thought the Treasury would boost both issues by $500 million.

Late yesterday, the when-issued two-year note was bid at 4.73% and the when-issued five-year was yielding 6.08%.

The March bond futures contract closed 5/32 higher at 104 3/32.

In the cash market, the 75/8% 30-year bond was 6/32 higher, at 102 7/32-102 11/32, to yield 7.42%.

The 6 3/8% 10-year note rose 11/32, to 97 8/32-97 12/32, to yield 6.74%.

The three-year 5 1/8% note was up 7/32, at 99 29/32-99 31/32, to yield 5.13%.

Rates on Treasury bills were mixed, with the three-month bill unchanged at 3.22%, the six-month bill down seven basis points at 3.34%, and the year bill six basis points lower at 3.57%.

Prev. Prev.

Wednesday Week Month

3-Month Bill 3.27 3.29 3.18

6-Month Bill 3.42 3.43 3.43

1-Year Bill 3.69 3.64 3.64

2-Year Note 4.60 4.59 4.52

3-Year Note 5.13 5.12 5.07

5-Year Note 6.03 6.01 5.94

7-Year Note 6.39 6.38 6.37

10-Year Note 6.74 6.73 6.75

30-Year Bond 7.42 7.43 7.50

Source: Cantor, Fitzgerald/Telerate

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