Solid buying interest for the long bond yesterday helped prop up the rest of the market and cause further flattening of the yield curve.
The 30-year bond ended the session up 15/32 to yield 6.51%.
The long end outperformed other issues for the second day in a row as investors moved money into longer maturities to gear up for a six-month drought in bond sales.
Following next week's refunding, two full quarters will pass before the Treasury Department auctions bonds again.
That lack of new supply hitting the market, coupled with slow economic growth and bright prospects for inflation, helped the yield on the bond hit the psychologically important 6.50% level.
Traders said all other issues moved higher in sympathy with the long end.
"Lack of supply in bonds and the flattening yield curve are helping bonds considerably," said Gilbert Clark, head government securities trader at Daiwa Securities America Inc.
Moment-to-moment price movements were dominated by concerns over the budget. Rumors of the Democrats winning over one or more of the Senators who had voted against the budget the first time trickled into and out of the market.
While the final version of the deficit reduction plan is likely to be voted on later in the week, market participants were confident late yesterday that it will squeak by Congress.
Carry-over support from other fixed-income instruments continued to benefit the market. Traders said that Treasury securities are being purchased as replacements for large amounts of mortgage-related and municipal bonds subject to early retirement, many of which are being redeemed or refunded prior to final maturity to take advantage of low rates.
Treasury prices opened on a firm note yesterday as buyers came into the intermediate sector of the market to take advantage of attractive yield levels brought on by yesterday's sell-off.
Talk that the Treasury would cut the size of the upcoming bond auction directed further buying interest toward the long end of the curve. Most analysts on the Street expect the upcoming refunding package to contain about $11 billion in 30-year bonds.
Those rumors touched off a short-covering rally early in the session as traders were forced to cover positions set in expectation of lower prices.
A slight boost also came from the leading indicators report. The Commerce Department reported a 0.1% increase in the overall index in June. The market keyed off a sharp 0.3% drop in the coincident index contained in the report.
The coincident indicator is a measure of economic activity that moves broadly in line with the general business cycle, such as industrial production and retail sales.
Carol Stone, money market economist at Nomura Securities, said the report, particularly the coincident index. supported the findings of last week's gross domestic product report.
"We continue to see this hesitant, almost flattish trend in economic activity," she said.
At midday, the market was faced with a classic "buy the rumor, sell the fact" scenario. Prices firmed late in the morning on rumors of a coupon pass. When the Federal Reserve failed to make a permanent addition of reserves, the market sold off slightly.
"The market had hoped that it would see a coupon pass before the refunding announcement and it was disappointed when it didn't happen," said Mary Dennis, economist at Merrill Lynch Government Securities.
Dennis now expects a coupon pass immediately following next week's refunding auction, as projections show that the central bank has a large add need this week.
On the economic data front this week, the Fed's "beige book" report on economic activity and the employment report for July will help set the market's tone going into the refunding auctions.
Charles Lieberman, director of financial markets research at Chemical Securities, said that today's report from the Fed has taken on greater significance because the market fears any sign of strength in the economy or upward pressure on inflation.
"I'm particularly interested to see the discussion about inflation." Lieberman said. "[Fed Chairman Alan] Greenspan clearly said that he's concerned about inflation down the road, and I think that's going to be the market's main concern where this report is concerned."
In futures trading, the September bond contract ended up 11/32 at 115.24.
In the cash markets, the 4 1/8% two-year note was quoted late yesterday up 2/32 at 100.05-100.06 to yield 4.15%; the 5 1/8% five-year note ended up 5/32 at 100.10-100.12 to yield 5.16%; the 6 1/4% 10-year note was up 7/32 at 103.06-103.08 to yield 5.80%; and the 7 1/8% 30-year bond was up 15/32 at 107.27-107.29 to yield 6.51%.
The three-month Treasury bill was down one basis point at 3.13%; the six-month bill was down two basis points at 3.30%; and the year bill was down one basis point at 3.54%.
The economic advisory committee of the Public Securities Association forecasts stronger economic growth and steady monetary policy for the second half of the year.
In a report released yesterday, the committee concluded that the U.S. economy will remain on a slow growth path, with minimal inflation and steady interest rates.
Real gross domestic product growth of 2.6% is expected for 1993. That contrasts with the PSA's previous forecast for 3.1 % in March, on the back of surprisingly strong 4.7% GDP growth in the fourth quarter of 1992.
Inflation is also seen as rising, albeit modestly, as price pressures were seen as bottoming out in 1992 at 3%. A 3.2% for the consumer price index is forecast for 1993.Treasury Market Yields Prev. Prev. Tuesday Week Month3 Month Bill 3.13 3.14 3.026-Month Bill 3.30 3.34 3.201-Year Bill 3.54 3.59 3.422-Year Note 4.15 4.19 3.993-Year Note 4.44 4.50 4.315-Year Note 5.17 5.22 5.037-Year Note 5.44 5.54 5.4210-Year Note 5.80 5.89 5.7730-Year Bond 6.52 6.67 6.67Source: Cantor, Fitzgerald/Telerate