Treasury prices surged Friday, with the strongest gains occurring at the short end, after the Federal Reserve announced it was cutting the discount rate a full point to 3.5%.

Late in the afternoon, the 30-year bond was up almost a point and yielded 7.57%, while short-term notes were up 3/8 tp 1/2 point.

The bond market was shocked by the full-point cut, since analysts had been expecting only a 1/2-point move. It was the first time since 1981 that the Fed had cut the discount rate a full point, and analysts

Treasury Market Yields

Prev. Prev.

Friday Week Month

3-Month Bill 3.75 4.24 4.53

6-Month Bill 3.94 4.32 4.67

1-Year Bill 4.08 4.42 4.74

2-Year Note 4.83 5.05 4.47

3-Year Note 5.16 5.40 5.81

4-Year Note 5.28 5.51 5.91

5-Year Note 6.03 6.26 6.55

7-Year Note 6.53 6.71 6.99

10-Year Note 6.95 7.19 7.43

15-Year Bond 7.62 7.54 7.77

30-Year Bond 7.57 7.76 7.97

Source: Cantor. Fitzgerald/Telerate

said the size of the move showed how worried the Fed is about the static economy.

"I think the Fed is panicking about the economy," said Ram Bhagavatula, chied economist at Citibank.

"The Fed is showing that it's firmly committed to moving the economy safely away from recession as quickly as possible," said John Lonski, senior economist at Moody's Investors Service. "I wouldn't rule out the possibility of additional easing during the early part of 1992."

The timing of the rate cut was also surprising. When the Fed refrained from changing monetary policy last Wednesday, the market decided the next opportunity for an easing would be after the December employment report on Jan. 10.

William Griggs, a managing director at Griggs & Santow Inc., said Fed may have held off until Friday in a deliberate attempt to get the maximum impact from the move.

"I suppose they're really trying to capture the headlines and draw people's attention to how rates have come down," he said. "I think they're hoping this type of dramatic move will bring about a change in psychology."

Almost all the price move in the Treasury market occurred right after the Fed's announcement, although the long end managed to move a little higher during the afternoon session.

Later Friday morning, the Fed added reserves to the monetary system with six-day system repurchase agreements when Fed funds were trading at 4 1/8%. Economists said the intervention showed the Fed was targeting a 4% funds rate, down a half point from the previous 4 1/2% target.

The Fed's rate cuts had more impact on the short end, and that caused the yield curve to reverse some of the flattening seen earlier last week.

Late Friday, the 30-year bond was yielding 274 basis points more than the two-year note, up from 262 late Thursday.

Traders said Treasury prices could move higher this week even though the holiday will leave trading desks looking like ghost towns.

"There's nothing particular in front of us to stop it," a note trader said. "The economy is in poor shape and the Fed has broken its gradualism and taken a big step here."

Hopes of further rate cuts should buoy the short end. But many traders are expecting the long end to perform the best as the extremely low yields on short-term paper drive investors out the curve.

With two-year notes yielding below 5% and five-year notes at 6%, "the bond is the only one with any type of sex appeal," the note trader said.

"People are looking to pick up yield now," a government bond trader said. "The 10s traded very well today, bonds are up strongly."

After the Fed's momentous announcement, none of Friday's indicators had much impact on the market.

The most bullish news for the bond market came from the Federal Reserve Bank of Philadephia. Its monthly business survey showed manufacturing activity in the Philadelphia area deteriorated sharply in December.

Michael Niemira, business economist at Mitsubishi Bank, said the decline in Philadelphia suggests the national purchasing managers' December index will fall to 47% or 48% from its 50.1% November reading.

Also on Friday, the final version of third-quarter gross domestic output showed a 1.8% increase, little changed from the 1.7% gain reported in the previous revision two weeks ago. And the Treasury said the government ran a $45.5 billion deficit in November, in line with expectations and slightly below the $47.6 billion gap in November 1990.

The March bond future contract closed at 102 23/32, up 27/32 on the day.

In the cash market, the 30-year 8% bond was 31/32 higher, at 104 28/32-105, to yield 7.57%.

The 7 1/2 10-year note rose 29/32, to 103 24/32-103 28/32, to yield 6.95%.

The three-year 6% note was up 7/16, at 102 5/32-102 7/32, to yield 5.16%.

In when-issued trading, the 5% two-year note was up 3/8 at 100 9/32-100 10/32 to yield 4.83%, which marks a sharp improvement from the 5.12% average at Wednesday's auction.

The when-issued 6 1/8% five-year note was up 19/32 at 100 11/32-100 13/32 to yield 6.03%, down from the 6.24% average at Thursday's sale.

Rates on Treasury bills were lower, with the three-month bill down 32 basis points at 3.72%, the six-month bill off 32 basis points at 3.83%, and the year bill down 27 basis points at 3.92%.

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