An unexpected downward revision to second-quarter output put the Treasury market back in a good mood yesterday.

The news that the gross national product fell in the second quarter, instead of increasing as was reported last month, reinforced the market's hopes for another Fed easing.

Prices began to improve on that news, then made further gains during the afternoon on the successful five-year auction and the Federal Reserve's announcement that it would buy bills for its own account.

By late in the day, the 30-year bond was up 3/4 point, where it yielded 8.05%, and short-term notes had gained about 1/4 point.

The Commerce Department said yesterday morning the gross national product decreased 0.1% in the second quarter, rather than growing 0.4% as was originally reported.

That means the U.S. economy posted three quarters of negative growth in a row, since GNP fell 2.8% in the first quarter and 1.6% in the fourth quarter of last year. That has happened only two other times since World War II.

"The GNP revision is friendly, as it renews the feeling that the Fed is going to have to ease and the durables goods data we saw Friday were an aberration," said Karen Gibbs, a senior futures analyst at Dean Witter Reynolds Inc.

Ms. Gibbs said the upward revision to the second-quarter implicit deflator, to a 4.2% increase from the 3.9% gain originally reported, at first kept a lid on long-term prices.

"But when the short end rallied, it pulled the long end up," she said.

Traders said they saw good retail buying starting right after the GNP report. And the second leg of yesterday's rally began when the Federal Reserve lined up on the buy side, too, announcing at midday that it would purchase bills for its own account after the note auction.

Prices reached their highs after the five-year results showed the auction had gone better than expected.

The $9.3 billion of five-year notes were auctioned at an average yield of 7.37% and will bear a 7 1/4% coupon, down from the 7.89% average and 7 7/8% coupon at last month's five-year sale.

The auction did tail back to 7.38%, but only 9% of the bids entered at that level were accepted, surprising some participants.

"It didn't have as much as a tail as people were looking for," said Steven Slifer, a money market economist at Lehman Brothers. "As a result, some people got shut out and were forced to do a little covering, which accounts for some of the run-up."

A note trader said most of yesterday's gains were due to "good old-fashioned better buying," but agreed that the auction results were also a factor. "I don't think we'd be here if the boys were allowed to buy what they wanted to buy at 38."

As dealers scrambled in the secondary market to get the securities they missed buying at the auction, they pushed the yield of the new five-years as low as 7.31%, marketing a sharp improvement from the 7.37% auction average.

The new two-year notes were also well above their price at Tuesday's auction; late yesterday, the when-issued 6 3/8% two-years were up 3/16 at 100 4/32-100 5/32 to yield 6.29%. The two-years were auctioned at an average of 6.46%.

Traders said the prices could go higher. With this week's two-year and five-year sales successfully completed, the next coupon supply will not arrive until late September.

"If we continue to see retail buying and the news breaks okay, we can continue to go higher," a coupon trader said.

Today's auction of $5 billion of cash management bill is not seen as a problem. The market will focus instead on today's indicators, including the weekly jobless claims, July new home sales and personal income, and the money supply figures.

Even though the downward revision to GNP set off yesterday's rally, some economists saw positive news in the number.

Whether second-quarter growth was down 0.1% or up 0.4%, "the basic message is that economic activity stabilized in the second quarter after two quarters of recessionary decline," said Joan Schneider, a money market analyst at Continental Illinois National Bank & Trust. "It certainly looks as if we'll have significant positive growth in the third quarter."

In fact, the biggest revision, a $6.5 billion drop in inventories, is a good omen for the second half, analysts said.

"Final sales were almost unchanged, so it looks as if we bought more stuff out of inventories than we thought," said Cynthia Latta, a financial economist at DRI/McGraw Hill. "Inventories will be leaner going into the third quarter and that will support production."

The September bond future contract closed 7/8 higher at 98 4/32.

In the cash market, the 30-year 8 1/8% bond was 25/32 higher, at 100 22/32-100 26/32, to yield 8.05%.

The 7 7/8% 10-year note rose 1/2, to 100 12/32-100 16/32, to yield 7.80%.

The three-year 6 7/8% note was up 1/4, at 100 19/32-100 21/32. to yield 6.62%.

Rates on Treasury bills were lower, with the three-month bill down seven basis points at 5.30%, the six-month bill of 11 basis points at 5.31%, and the ytear bill 12 basis points lower at 5.35%.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.