Long-term Treasury prices rallied sharply yesterday afternoon as optimism about inflation and worries about the economy pushed bond rates to levels not seen in over four years.

The long bond closed 1 1/8 points higher, where it yielded 7.65%, the lowest closing yield since March 1987.

The market began to improve yesterday morning on the 79,000 jump in initial jobless claims, and the rally at the long end picked up speed after the results of the two-year note auction were released.

But analysts said the move to lower yield levels reflected an important shift in psychology at the long end, which has stubbornly lagged the rest of the market in recent months.

"There's a growing sense here that a we move into 1992, bond yields are going to fall precipitously," said Steve Slifer, a money market economist at Lehman Brothers.

Mr. Slifer said the long end was pricing in the realization that the economy is going nowhere and inflation is improving.

He argued that the Federal Reserve's failure to cut key rates Wednesday, as most analysts expected, had added to the long end's optimism about inflation.

"If anybody had worried the Fed was moving too quickly, this delaying action on the Fed's part seems to have made market participants believers that inflation is going to move lower," he said.

Traders and analysts said Fed Chairman Alan Greenspan's downbeat comments on Capitol Hill Wednesday had brought home the severity of the economy's problems.

Treasury Market Yields

Prev. Prev.

Thursday Week Month

3-Month Bill 4.12 4.25 4.54

6-Month Bill 4.28 4.31 4.67

1-Year Bill 4.37 4.44 4.74

2-Year Note 5.03 5.02 5.46

3-Year Note 5.33 5.37 5.81

4-Year Note 5.44 5.50 5.91

5-Year Note 6.19 6.21 6.53

7-Year Note 6.66 6.70 6.97

10-Year Note 7.08 7.17 7.39

15-Year Bond 7.69 7.48 7.75

30-Year Bond 7.65 7.74 7.96

Source: Cantor, Fitzgerald/Telerate

"He was extremely candid in his pessimism," said Scott Winningham, chief market analyst at Stone & McCarthy Research Associates in Princeton, N.J.

Traders said the successful five-year sale yesterday afternoon had helped the market move higher.

A bond trader pointed out that after making some gains during the morning, the bond futures contract had seen some volatile trading after the five-year bids went in.

"The five-years were clearly well spoken for, and I think that convinced people it was safe to buy," a bond trader said.

The $9 billion of notes were sold at an average yield of 6.24% and will bear a 6 1/8% coupon.

The fact that the average came at 6.24%, instead of the 6.25% traders expected, was one sign of the strong demand for the notes. The 3.64-to-1 bid to cover ratio and the $797 million of noncompetitive bids, both well above average for a five-year sale, were further evidence of the demand.

As participants who missed getting what they needed at the auction tried to buy the notes in the secondary market, the price rose and the yield fell. By late yesterday, the yield on the when-issued five-years had fallen to 6.19% from the 6.24% average at the auction.

The market began to move higher yesterday morning after the Labor Department reported that new claims for unemployment insurance rose 79,000, to 493,000 in the week ended Dec. 7, after falling 61,000 in the previous week. The total number of people receiving state benefits increased 419,000 to 3.477 million in the week ended Nov. 30.

"Jobless claims got the market on its feet," a coupon trader said.

But analysts said the improvement in claims had been anticipated because the previous week's claims had been depressed by Thanksgiving and the fact that some states closed their offices two days, instead of one, for the holiday.

Kathleen Camilli, chief economist at Ramirez Capital Consultants, said one striking number in the claims report was the 635,000 people who applied in the week ending Nov. 30 for the extended unemployment benefits authorized by Congress last month.

"The most staggering thing about this is the speed with which people have applied," Ms. Camili said. "It really highlights the severity of the unemployment picture in a way that the regular rate does not show."

The market was less interested in the news that October's merchandise trade deficit totaled $6.73 billion, in line with expectations.

The October deficit was down from a revised gap of $6.93 billion in September, and reflected the disparity between a record $36.7 billion of exports and and $43.5 billion of imports.

The March bond future contract closed 31/32 higher at 100 29/32.

In the cash market, the 30-year 8% bond was 1 1/8 higher, at 103 30/32-104 2/32, to yield 7.65%.

The 7 1/2% 10-year note rose 23/32, to 102 26/32-102 30/32, to yield 7.08%.

The three-year 6% note was up 3/16, at 101 22/32-101 24/32, to yield 5.33%.

In when-issued trading, 5% two-year note was 5/32 higher, at 99 29/32-99 30/32, to yield 5.03%.

Rates on Treasury bills were lower, with the three-month bill down eight basis points at 4.04%, the six-month bill down four basis points at 4.15%, and the year bill off four basis points at 4.19%.

In other news, a spokesman for the Federal Reserve Bank of New York reported at the weekly press briefing that the nation's M1 money supply fell $6.5 billion, to$894.9 billion in the week ended Dec. 9; the broader M2 aggregate gained $800 million, to $3.4 trillion; and M3 increased $6.7 billion, to $4.2 trillion, in the same period.

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