Unexpectedly strong news on the U.S. economy and tepid demand for new government paper sent Treasuries lower yesterday, particularly at the long end of the yield spectrum.

Long-dated governments took the brunt of the selling, reacting negatively to evidence that the economy continues to expand apace and that retail investors have not returned to the market in force.

The benchmark 30-year bond ended down more than 5/8 of a point, to yield 7.60%, while the two-year note finished the session down 3/32 at a yield of 6.21%.

With the national economy exhibiting few signs of weakness, market participants wonder how far behind inflation pressures can be. Against that backdrop, larger accounts remain unwilling to take on new market risk and are avoiding Treasuries.

The June durable goods orders report showed that the economy in general and the factory sector in particular are not slowing down in the second half of the year, providing further justification for the Federal Reserve to raise interest rates at the meeting in August of the Federal Open Market Committee meeting, observers said.

The Commerce Department reported that durable goods rose a stronger-than-expected 1.3% in June. That was compared with the median forecast in a Bond Buyer survey for a 0.5% gain. Excluding defense, new orders were up 1.5%, while orders excluding transportation rose 1.0%. Causing the largest stir among bond market players was the 6.2% surge in new orders for nondefense capital goods, which marked the first increase in that sector since January, with gains in almost every category.

"The report showed the economy remains durable," said Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson, Inc."While the consensus economic forecast is for an economic slowdown during the second half of 1994, the durable goods data do not concur."

Market observers did not think the Fed would react specifically to the June durables report, but they agreed that it gave the central bank another reason to raise rates.

Wesbury said testimony by Fed chairman Alan Greenspan last week was supported by the durables report. While one-month moves in durable goods are not a good indicator, the combination of a rebound in capital goods, rising untilled orders, strength in shipments, and double-digit 12-month growth rates in new orders all point to continued strong economic activity in the months ahead, he said.

"The FOMC meets on Aug. 16 and the data is building enough to suggest that they should tighten monetary policy again," Wesbury said.

Governments were able to muster little support following the second leg of the Treasury's monthly note auctions. The Treasury awarded $11 billion of five-year notes at a yield of 6.98%, basically near market expectations. The bid-to-cover ratio was on the low side at 2.56 to 1, as were non-competitive bids at $735 million.

The lackluster auction results reflect fears that the Fed will soon act to rein in credit as well as concerns over the market's ability to absorb upcoming supply as the Treasury conducts its quarterly refunding, said Marilyn Schaja, money market economist at Donaldson, Lufkin & Jenrette Securities Corp.

Getting part of the blame for the tepid demand for new government securities is upcoming economic statistics, which include second quarter gross domestic product, June new home sales, and July employment, she said.

"Everyone is nervous about the refunding and we do have some important data coming that might portend a change in Fed policy," Schaja said.

The conspicuous lack of sponsorship from retail accounts has been a major problem for the Treasury market in recent sessions. Players on the buy-side of the market are finding it more appealing to follow the trend than hold a view on the market.

Most 'attribute the falloff in retail interest to uncertainty about the future of U.S. monetary policy and a reluctance to risk being caught on the wrong side of the market if and when the Fed moved again.

Greenspan, in his semiannual Humphrey-Hawkins testimony last week before the Senate Banking Committee, indicated that the central bank is still concerned over the pace of economic growth, inflation, and the weak U.S. dollar. Bond market players took the comments to mean that the Fed will again raise rates.

Since the testimony, fixed income market professionals have begun to change their investment strategies to account for higher short-term interest rates. That has generally meant money flowing out of the short end of the government securities market and into longer maturities, which are thought to have the most to gain from tighter credit.

Market observers do not expect retail to come off the sidelines anytime soon. In a weekly survey of U.S. money managers conducted by Stone & McCarthy Research Associates, fixed income managers were more cautious in the most recent week than last, with fewer intending to be active in the market.

Stone & McCarthy analyst John Canavan attributed the drought of buyside demand for Treasuries to a general lack of incentives to get involved in the market. Larger accounts, he said, want to see the July employment figures before committing themselves to new positions in the market.

Asserting that the upcoming jobs report will play a crucial role in the Fed' s deliberations about monetary policy and the success of August refunding, Canavan said money managers and the Treasury market in general are probably destined to play the range in coming sessions.

"This is one dull market," Canavan said.

Corporate Securities

As talk of tighter Fed policy resurfaced yesterday, corporate market participants generally waded to the sidelines.

The primary market mustered one straight corporate deal, while most corporate treasurers felt more comfortable leaving their offerings on the shelves in search of more stable fixed income markets.

Participants spent the better part of the session attempting to distribute this week's new issues. Among the deals priced this week were ABM Amro Bank's $200 million of 15-year subordinated notes to yield 8.275%, Corning Inc.'s $100 million in 30-year bonds, and International Lease Finance Corp.'s $100 million of three-year senior notes. Treasury Market Yields Prev. Prev. Wednesday Week Month 3-Month Bill 4.54 4.38 4.23 6-Month Bill 5.02 4.86 4.73 1-Year Bill 5.54 5.33 5.43 2-Year Note 6.21 5.99 6.10 3-Year Note 6.48 6.32 6.38 5-Year Note 6.96 6.81 6.85 7-Year Note 7.13 7.00 6.88 10-Year Note 7.32 7.22 7.21 30-Year Bond 7.60 7.54 7.50

Source: Cantor, Fitzgerald/Telerate

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