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U.S. Treasury Notes Rise as Economy Expanded Less Than Forecast

July 30 (Bloomberg) -- U.S. Treasury notes surged after the economy and personal consumption expanded less than forecast last quarter, raising speculation the Federal Reserve will refrain from accelerating the pace of interest-rate increases.

Traders pushed the benchmark 10-year note up by the most in two weeks. Evidence growth is waning may cast doubt on Fed Chairman Alan Greenspan's assertion in congressional testimony last week that a slowdown seen in June would be ``short-lived.''

``The numbers show that the economy is slowing; to us this means the Fed will continue to tighten, but at a modest pace,'' said Ashok Varadhan, head of U.S. interest-rate products at Goldman, Sachs & Co., one of the 22 primary dealers of U.S. government securities that trade with the central bank's New York branch. ``All of this is very positive for bond prices.''

At 11:43 a.m. in New York the 4 3/4 percent note maturing in May 2014 rose almost 3/4, or $7.50 per $1,000 face amount, to 102 1/16, according to bond broker Cantor Fitzgerald LP. Its yield fell 9 basis points, or 0.09 percentage point, to 4.49 percent, and is down from 4.58 percent at the end of June, the second straight monthly decline.

Today's gains weren't enough to keep the note's price from dropping for a second straight week, after the Conference Board said Tuesday its measure of consumer confidence for July rose.

Gross domestic product, the value of all goods and services produced in the U.S., grew at a 3 percent rate in the second quarter, from a revised 4.5 percent in the first quarter, the Commerce Department said. The median forecast of economists polled by Bloomberg News was for a 3.7 percent rate. Personal consumption grew 1 percent last quarter, half the clip projected, and down from 4.1 percent in the second quarter.

Buying Treasuries

Treasuries also got a boost as crude oil rose to a record high of $43.45 per barrel, fueling concern rising energy prices will crimp consumer spending.

Michael Cheah, who manages $2 billion of bonds at AIG SunAmerica Funds in Jersey City, New Jersey, said he bought 10- year notes after the numbers, particularly because of the personal consumption statistics.

``This is a bit troublesome for the Fed; there is a chance the Fed may skip one meeting'' this year, contrary to some economists' view the central bank will raise rates at each of its four remaining meetings, he said.

The yield on the December Eurodollar futures contract fell 5.5 basis points to 2.37 percent, and is down from 2.49 percent on Tuesday. The contract settles at a three-month lending rate that has averaged about 22 basis points above the Fed's target in the past 10 years.

2 Percent By Year-End

Economists at 18 of the 22 primary U.S. government securities dealers that trade with the Fed's New York branch predict the central bank will boost its target for overnight loans between banks to 2 percent or more by year-end, according to a Bloomberg News survey published this week. Seven of the firms projected a rate of 2.25 percent or higher by Dec. 31.

Demand for Treasuries started rising before the GDP data on the report of a suicide bombing outside the Israeli embassy in Tashkent, the capital of Uzbekistan, said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York.

Reports this month showing a drop in retail sales, smaller- than-forecast job creation and slower inflation for June caused traders to trim bets on the size and pace of further increases in the Fed's key interest rate, currently at 1.25 percent.

Greenspan then said in congressional testimony on June 20-21 that June's slowdown would likely prove ``short-lived.'' Reports on July manufacturing for New York state and the Philadelphia region surged, and the Conference Board said this week its consumer confidence index rose to a two-year high.

`Old News'

``It's all old news and one of the reasons rates rallied so much from mid-June,'' Peter McTeague, co-head of interest-rate strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut, wrote in a research note before the report. ``More critical'' is growth this quarter, he wrote.

McTeague was ranked the top U.S. government debt strategist last year in an Institutional Investor magazine poll. RBS is also a primary dealer.

Yields on two-year notes, which are more sensitive to changes in monetary policy, fell less than yields on 10-year notes. The 2 3/4 percent note due in July 2006 rose almost 1/8 to 100 1/8, as its yield dropped 7 basis points to 2.69 percent.

The U.S. economy may grow 4.5 percent this year, the fastest since 1999, based on the median estimate of economists polled by Bloomberg News June 25 to July 6.


Excluding energy and food, a measure of inflation tied to consumer spending slowed. The core personal consumption expenditures index, used by the Fed in making its forecast, rose 1.8 percent at an annual rate in the second quarter after a 2.1 percent pace. The measure is now within the central bankers' forecast of 1.5 percent to 2 percent for the year.

Subtracting the year-over-year consumer price inflation rate, 10-year notes yield 2.61 percent, compared with an average of 2.83 percent since the start of the year.

``The market is starting to price in a slowdown in the economy, one that's more than temporary,'' said Mario De Rose, fixed-income strategist at Edward Jones & Co. in St. Louis. The Fed ``has the luxury to gradually raise interest rates.''

Also today, the University of Michigan said its index of consumer sentiment this month rose to 96.7, from a preliminary reading of 96 reported on July 16.

Chicago-area business activity strengthened this month, the National Association of Purchasing Management-Chicago said. The group's index of manufacturing and other business activity rose to 64.7 in July from 56.4. Readings above 50 signal expansion.

``Generally, we're negative on the bond market,'' said Chris Lupoli, a bond strategist in London at UBS AG. ``If we see inflationary pressures coming through, the Fed could move to an accelerated pace of tightening from a measured pace.'' A 10-year yield of 5 percent ``isn't unreasonable,'' he said.

The Bush administration cut its forecast for the U.S. government budget deficit to $445 billion for this fiscal year as a strengthening economy bolsters tax revenues, people familiar with the situation said. The shortfall will still be a record, topping last year's $374 billion gap.

The deficit for fiscal 2005, which begins Oct. 1, will be $331 billion, the people said.





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