Could August be the month when the U.S credit markets finally get a rest from the exhausting declines of late?

Some Wall Street professionals think it might.

As traders sit down at their desks this morning, they are more optimistic that the bond market is on the verge of extending Friday's rally.

Their optimism stems from the belief that two key economic reports due this week will support the notion that growth is slowing and halt the relentless rise in interest rates. Market players looking for a reason to rally found it in last week's second-quarter gross domestic product report. Treasury yields plummeted Friday as the GDP figures showed a 3.7% growth rate during the second quarter. While the report generally matched market expectations, it was disappointing to some who were predicting a sharper rise.

The news came as a relief to bond market players, particularly since much of the gain reflected inventory rebuilding, which could limit gains in coming months.

In some comers of the bond market, players expressed the view that the buildup in inventories could postpone the next tightening of monetary policy the market expected by midAugust. The notion reinvigorated the short end of the Treasury market and encouraged retail investors to stock up on short-term securities.

Treasury prices surged across the yield spectrum Friday as dealers covered short positions and retail accounts funneled back into the market to take advantage of attractive yield levels brought on by the market's recent sell-off. The benchmark 30-year bond closed up more than 1 3/4 points, to yield 7.38%, its lowest closing level in six weeks.

Now the question remains: Will the buying frenzy continue? Standing in the market's way are this week's offering of economic reports. Today's July report from the National Association of Purchasing Management and Friday's July employment report could show that the economy lost steam last month, keeping the Federal Reserve in its holding pattern and attracting more retail investors back into the market.

"I think the rally is sustainable, but you still have some data to get through before we can," said Donald Fine, chief market analyst at Chase Securities Inc.

Should the reports support the slower growth scenario being played out in the national economy, particularly the employment report, Fine said that the bond market could extend recent gains. "If the payroll number shows slowing, I think this could continue," he said.

Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson Inc., said fixed-income market professionals had been looking for a reason to rally and the GDP report provided an excuse to push prices higher. However, he said that the employment report, not the GDP statistics, will be what the markets and the Fed will eventually take their overall direction from.

While some economists, including Anthony Karydakis of First Chicago Capital Markets Inc., said that the GDP report gave the Fed room to leave rates unchanged at the upcoming Federal Open Market Committee meeting, other economists said growth in the second quarter was strong enough and the inflation figures high enough to keep the Fed on its present course and tighten credit on Aug. 16.

Karydakis, senior financial economist at First Chicago, said that the accumulation of inventories was so great that companies may spend much of the third quarter attempting to reduce stock levels, a development that could depress productivity and employment growth.

The Commerce Department reported a $54 billion boost in inventories in the second quarter following a $25.4 billion jump in the first quarter for a net increase of $28.6 billion.

Without the inventory boost, real GDP increased only 0.4%, Wesbury said. "This boost to inventories suggests that production will slow in the second half of this year unless consumption picks up strongly," he said. Slower growth was seen in consumer spending, which slowed to a 1.2% pace in the second quarter, after surging 4.7% in the first quarter and 4.0% in the fourth quarter of 1993.

The composition of the government's preliminary GDP estimate also helped calm nerves in the bond market. Final sales rose only 1.5% and the surge in inventories that accounted for much of the gain in second-quarter output could act as a drag on the economy in the third quarter.

But not all Wall Street professionals embraced the rise in inventory as a positive development for the fixed-income markets. Michael Strauss, chief economist at Yamaichi International Inc., said inventories rose mostly at the wholesale trade level, which he interpreted as a sign that U.S. companies are buying goods ahead of future price increases.

"The inventory accumulation resulted from companies trying to beat price increases associated with the weaker dollar," Strauss said.

The report's inflation measures came in slightly higher than expected. The fixed-weight deflator rose 2.9% in the second quarter, compared with a revised 3.1% first-quarter gain, and the implicit deflator was up 2.9% in the second quarter, matching it revised first-quarter gain. Eugene Sherman, director of research at M.A. Schapiro & Co., said inflation has risen steadily in the last 10 quarters, indication that price pressures in the national continue to rise, but so far not at a particularly alarming rate. But the persistent increases in inflation should be heeded by the financial markets, he warned.

"Stepping back from the emotion of the day, the bond market is gratified that the rate of inflation is not higher," Sherman said. "But the market should be aware that labor, capacity, and commodities are all rising."

Sherman expects the Fed to raise the federal funds rate by 50 basis points by Aug. 16, a move that would be aimed at controlling inflation and supporting the fragile U.S. dollar.

A view making the rounds in the bond market recently is that a tightening of policy would restore stability to Treasuries and give larger accounts more confidence to buy securities. Some observers believe that if the central bank raised shortterm rates at the next FOMC meeting, it would remove uncertainty from the bond market and reduce investors' inflation expectations. In fact, some believe leaving monetary policy unchanged could do more harm to the market than good.

"This is one of the most ideal times for the Fed to tighten," said Chase's Fine. "The greater risk is to do nothing in August and let the economy get away from them. That would risk an 8% long bond." Economists polled by The Bond Buyer generally expect nonfarm payrolls to increase by 200,000 in July, with most seeing the civilian unemployment rate rising marginally to 6.1%.

In the secondary market for corporate securities Friday, spreads of investment grade issues generally tightened by 3/4 to a point, while high yield issues improved by 1/2 of a point.

In the futures market, the September bond contract ended the week up 1 3/4 points at 104.25.

In the cash markets, the 6 1/8% two-year note was quoted late Friday up 1 1/32 at 100.07-100.08 to yield 5.99%. The 6 7/8% five-year note ended up more than 3/4 of a point at 100.19-100.21 to yield 6.71%. The 7 1/4% 10-year note ended 1 1/4 points at 100.31-101.03 to yield 7.09%. The 6 1/4% 30-year bond ended up more than 1 3/4 points at 86.13-86.17 to yield 7.38%.

The three-month Treasury bill ended down 14 basis points at 4.36%. The six-month bill closed down 15 basis points at 4.84%. The year bill also ended down 16 basis points at 5.34%.

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