Short-term Treasury prices declined yesterday when a newspaper article reawakened speculation that the Federal Reserve will raise short-term rates.

The market bounced off its lows when a surprisingly weak May durable goods report offset the talk of a Fed tightening, but short-term prices never completely erased their initial losses.

Late yesterday, short-term notes were marginally lower on the day, and the 30-year bond was up 1/8 point and yielded 6.75%.

Treasury prices plunged in overseas trading after The New York Times suggested the Federal Reserve will raise short-term rates by the end of the summer.

According to the newspaper, Fed officials are considering tightening monetary policy in what the article called a "preemptive strike" against inflation.

The article, which quoted Fed vice chairman David Mullins, said Fed officials are worried about investors' expectations of future inflation and think a small tightening move is possible given the decent growth in the economy.

Analysts said the article contained little new information. The bond market already realized that Fed policymakers were worried about the run of high monthly increases in inflation during the early part of this year.

Charles Lieberman, a managing director at Chemical Securities. said the weakness in some recent economic reports, including yesterday's May durables orders, combined with the recent improvement in inflation reports, would forestall any Fed tightening.

The article "is actually a week or two out of date," he said. "In the last couple of weeks, the data have come in considerably weaker than the markets were anticipating, and senior Fed officials have stated publicly that inflation may not be as much of a problem as anticipated.

"I think the Fed is committed to that strong anti-inflationary view, but the urgency for doing something has clearly passed because the numbers are a lot better," Lieberman said.

Bob Dieli, a business economist at Northern Trust Co., said the Times article was just more "sabre rattling, " as Fed officials attempt to convince the markets of their firm stance against inflation.

But Joseph Liro, chief economist at S.G. Warburg & Co., said he thought the Fed was likely to tighten once it gets sufficient evidence that the economy is improving.

"If the economy shows sustainable growth for the next several months, I think the Fed would like to snug up the funds rate to where they think the inflation rate is, to 3.25% to 3.5%," Liro said. Currently, the Fed is targeting a 3% funds rate.

That possibility means the short end of the market will continue to underperform the rest of the market, Liro said. "The safest bet is the curve continues to flatten," he said.

Liro expects the June economic statistics to show more strength, and said that as the market starts getting more consistently upbeat indicators, "it will become increasingly clear that the Fed will have the scope to make a modest move toward restraint."

Given the talk about a Fed tightening, the drop in May durable goods orders came as a relief to the bond market.

May durables orders fell 1.6%. when the consensus forecast called for a 1% gain.

The May decline in durables was the third in a row. April's change was revised to show a 0.2% decrease and March orders fell 3.4%.

"The durable goods report was devastating. It was just uniformly weak across the board," Lieberman said.

Defense orders led the May decline, posting a 13.2% drop. But when defense orders were excluded, May durables orders were still off 0.8%, and orders excluding transportation goods fell 1.3%.

Lieberman said durables orders had slumped because "growth in the U.S. is moderate and foreign demand is flat-out weak, and that's not a very good combination for domestic manufacturing. "Fortunately, it's not enough to scotch the recovery," he said. Yesterday's five-year note sale went smoothly and had little impact on Treasury prices.

The Treasury sold $11 billion of five-year notes at the dutch auction's high yield of 5.23%. which matched the market's expectations.

The new 5 1/8% five-year notes moved higher in secondary trading after the auction results were announced, and by late in the afternoon, the price had gone up enough to push the yield down to 5.19%.

Traders said the uncertainty created by the Times article scared retail investors away from the note auction.

But the lack of retail interest worked out to the Street's advantage, they said, because it meant dealers bid cautiously and ended up getting the notes at a small concession.

Traders said they also saw retail buying at the lower price levels over the course of the day, as well as one purchase of more than $1 billion seven-year notes for a municipal defeasance deal.

The market was too busy worrying about Fed monetary policy to pay much attention to the rest of yesterday's economic news.

The Commerce Department said the nation's gross domestic product grew only 0.7% during the first quarter, instead of the 0.9% increase reported last month. But economists said the revisions were minor and they expect better growth, of about 2.5%, in the second quarter.

Mid-June car sales came in weaker than expected at a 6.6 million annual sales pace. That compares with the 6.8 million sales pace during the first 10 days of the month. And the Federal Reserve's "beige book," a compilation of economic updates from the district Fed banks, said the economy grew at a "slow to moderate pace" in May and early June.

The September bond futures contract closed 1/8 higher at 112 19/32.

In the cash market, the 7 1/8% 30-year bond was 5/32 higher, at 104 19/32-104 21/32, to yield 6.75%.

The 6 1/4% 10-year note rose 2/32 to 102 20/32- 102 22/32, to yield 5.88%.

The three-year 4 1/4% note was down 2/32, at 99 11/32-99 13/32, to yield 4.45%.

In when-issued trading, the 4 1/8% two-year note was 2/32 lower, at 99 28/32-99 29/32, to yield 4.17%. On Tuesday, the notes were auctioned at 4.16%.Treasury Market Yields Prev. Prev. Wednesday Week Month3-Month Bill 3.17 3.08 3.086-Month Bill 3.30 3.22 3.261-Year Bill 3.61 3.42 3.432-Year Note 4.17 4.05 4.143-Year Note 4.47 4.41 4.515-Year Note 5.17 5.15 5.277-Year Note 5.53 5.54 5.7110-Year Note 5.88 5.92 6.0830-Year Bond 6.75 6.81 6.91Source: Cantor, Fitzgerald/Telerate

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