Treasury note and bond prices inched higher after yesterday's stronger-than-expected two-year note sale.
Late in the afternoon, the 30-year bond was up Vs point to yield 6.76%.
Activity was quiet as the market focused on the Treasury's auction of $16 billion of two-year notes.
The notes were sold at the dutch auction's high yield, which was 4.16%, when the market expected bids to be awarded at 4.17% or even 4.18%. Those who bid at the high yield of 4.16% got only 52% of what they had asked for.
The unexpectedly low yield meant some participants missed getting securities they needed. As those firms tried to buy the new two-year notes in the secondary market after the results were announced, the price on the notes rose enough to push the yield down to 4.15%.
"The auction went pretty well," said Alan Levenson, a money market economist at UBS Securities. "We were surprised by how strong the bid was going into it, and then it went out strong too. "
Kevin Logan, chief economist at Swiss Bank Corp., said the demand for the two-year notes showed that the market's worries about inflationary pressures and a possible tightening by the Federal Reserve. have subsided.
"Dealers and investors are comfortable with two-year notes right now because they've become convinced the Federal Reserve is not about to tighten monetary policy," Logan said. "So holding a two-year for a few months will probably give a decent return, especially when compared with the cost of carry or with the return on alternative investment, like three- or six-month bills."
The head of a Treasury trading desk said he thought a lot of the demand came from firms covering short positions. Most dealers have been pessimistic about the outlook for interest rates and consequently had large short positions, he said.
The desk head said the dealers' short positions may have been part of curve-flattening trades. Some traders pointed to the long bond's relatively weak performance yesterday afternoon as a sign that flattening trades had been unwound at the auction.'
Traders said they do not expect today's auction of $11 billion of five-years to go as smoothly as the two-year sale. Many think the five-years look expensive, and predict Treasury prices will drift a little lower going into the five-year sale.
Late yesterday, the five-year notes were bid at 5.18% in when-issued trading. An intermediate note trader said he thought the notes would be auctioned at a yield above 5.20%.
But the desk official argued that the five-year sale will benefit from the same short-covering demand that the two-year auction did.
"The dealers are so negative, I think the short base is a little bigger than we're giving it credit for," he said. "And going into quarter's end, there's a fair amount of pressure on each participant to get yourself covered."
Levenson said another difference is that the market faces economic news ahead of today's sale. There were no significant indicators released yesterday.
Today's news includes May durable goods orders, a revision to firstquarter output, and mid-UNE CAR sales figures.
"The technicals still say the market is a little overbought," Levenson said. "If we were to get a strong durable goods report, that might require a concession in the market before the auction to get it done."
The consensus forecast calls for a 1% increase in May durable goods orders. Levenson said an increase of 1.5% or more could push Treasury prices lower.
Also today, economists expect the gain in first-quarter output to be revised down to 0.8% from the 0.9% reported last month. Mid-June car sales are expected to come in at 6.9 million.
The September bond futures contract closed unchanged at 112 15/32.
In the cash market, the 7 1/8% 30-year bond was 2/32 higher, at 104 14/32-104 16/32, to yield 6.77%.
The 6 1/4% 10-year note rose 102 n19/32-102n21/32, to yield to yield 5.88%.
The three-year 41/4% note was up 1/32, at 99 13/32 99 15/32, to yield 4.44%.
Rates on Treasury bills were little changed, with the three-month bill steady at 3. 1 0%, the six-month bill unchanged at 3.19%, and the year bill one basis point lower at 3.36%.