Treasury prices made bullish noises for the third day in a row yesterday as current indicators pointed to a slowing economy.

The market's biggest adrenaline jolt yesterday came from the Federal Reserve Bank of Philadelphia's business outlook survey for September, particularly its prices paid and prices received components.

The current prices paid diffusion index declined somewhat to 40.4 in September from 48.4 in August, while the prices received index dropped to 15.0 this month from 24.5 in August. "That's what really got the market moving," said Steve Ricchiuto, chief financial economist at Barclay's de Zoete Wedd Securities Inc. "You get people on board, they get bullish, and it adds to the comfort level, which pushes the number up higher."

The long bond rose nearly half a point on the Philadelphia Fed news at midmorning. Volume was thin because of the Yom Kippur observance.

Kathleen Camilli, chief economist at MFR Inc., was unimpressed by the market's bullishness of the past three days. "When the market has a big down day, like last Friday [when the producer price index was higher than expected], there's going to be a technical correction," she said.

Bill Sharp, an economist at Smith Barney Inc., said that while the Philadelphia Fed's September survey was down off August's five-year high, it was "still extremely high."

"Barring the August number, it's still a five-year high," Sharp said. "Inflation acceleration is still there, but not as high as for August."

Market participants are still waiting for today' s production and capacity utilization figures. "They' re important because the capacity utilization figure gives signs of inflation to come," Ricchiuto said.

The numbers could easily reverse the bond market's tenuously positive sentiment. Consensus is for a 0.5% increase in industrial production and an 84.1 capacity utilization rate. '"Traditionally, inflation accelerates when the rate reaches the 83, 84, 85 area," said Joseph Liro, senior vice president and chief economist at S.G. Warburg & Co.

The industrial production index for August "will spotlight the persistent strength in the expansion," David Munro, chief U.S. economist for High Frequency Economics, predicted in a release.

"Growth in output will accelerate to at least 0.5% from just 0.2% in July. Vehicle production accelerated in August. It will accelerate more in coming months, based on current schedules in Detroit and sales. Other industries will post rises as well, based on the 30,000 rise in factory jobs last month and longer workweeks."

Liro pointed out that the Fed generates the capacity utilization number and pays attention to it when it considers tightening interest rates. The Fed has tightened the federal funds rate five times already this year, most recently by five basis points to 4.75% on Aug. 16, and it is expected to tighten again in November.

Also yesterday, the Commerce Department reported that business inventories rose 0.3% in July. Economists had expected an increase more along the lines of 0.7% if not 0.9%.

Liro said the consensus for business inventories "was significantly higher than the 0.3% we got." He said retail inventories fell 0.9%, showing a pronounced drop, and "that was the surprise." Analysts were looking for the retail number to go up about 0.5%.

"The economic pace is slowing down, but it doesn't pose a threat to the expansion," Liro said. "The economy still has an extremely good balance to it." And with the Philadelphia Fed report, "the bond market felt reassured that near-term threats to inflation are starting to abate," he said.

Overall, said Camilli of MFR, "two weeks ago there was a split in market views about the economy, one in which people saw slower growth in second quarter, and another camp that saw growth would continue at 3% or higher."

Camilli said that economists thought auto sales would stay low, but they went up. And last Friday' s producer price index was much higher than expected, at 0.6% instead of 0.4%.

"Both of these factors gave further credence to the view that growth continued to expand at least at a 3% rate in the third quarter, with no signs of a deceleration in inflation," Camilli said. As a result, she said, "folks in the second camp may be right."

While there have been more buyers than sellers this week, Camilli said, "it will be interesting to see if the new data in the next two to three weeks suggest that the economy's growth is stronger."

She sees a retest of the 30-year's 7 3/4% yield level in the next several weeks, posing a challenge to the current trading band of 7 1/8% to 7 5/8%.

The benchmark 30-year Treasury bond closed up 14/32 yesterday, to yield 7.63%.

The 10-year Treasury note was up 13/32 to yield 7.32%. The seven-year note rose 10/32 to yield 7.14%, and the five-year was up 8/32 to yield 6.94%.

The yield on the three-month bill was unchanged at 4.67%. The yield on the six-month bill was unchanged at 5.12%, and the yield on the one-year was down one basis point at 5.58%.

The December Treasury bond futures contract closed up 13/32 at 100.24.Treasury Market Yields Previous Previous Thursday Week Month 3-Month Bill 4.67 4.63 4.646-Month Bill 5.12 5.04 5.111-Year Bill 5.67 5.54 5.562-Year Note 6.24 6.19 6.193-Year Note 6.53 6.48 6.545-Year Note 6.94 6.88 6.917-Year Note 7.14 7.07 7.0910-Year Note 7.32 7.27 7.2630-Year Bond 7.62 7.55 7.49

Source: Cantor, Fitzgerald/Telerate

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