Wed Aug 25, 2004
By Pedro Nicolaci da Costa

NEW YORK (Reuters) - U.S. Treasury prices were mixed on Wednesday as economic data proved tepid and demand for an auction of two-year notes was thin.

While the durable goods and housing figures were not seen as bad enough to prompt a shift in market expectations for gradual interest rate hikes this year, the picture they painted was hardly of a gangbuster economic expansion.

Such lingering economic doubts helped lift longer maturities, with the benchmark 10-year note (US10YT=RR: Quote, Profile, Research) up 2/32 in price for a yield of 4.27 percent, down from 4.28 percent on Tuesday and smack in the middle of its recent trading range.

"The economy is generally slowing for a wide variety of reasons -- energy is one -- but also the stimulus is wearing off," said Alan Ruskin, research director at 4Cast Ltd.

"There's a lot of wishful thinking out there. I think the Fed is trying to talk up the economy to justify the tightening they want to do," he added.

Fed officials this week have touted the country's economic prospects and argued that the recent spike in oil prices would not derail the recovery.

Fed Bank of Atlanta President Jack Guynn on Wednesday repeated the mantra, noting the Fed would be flexible when considering the impact of high energy prices on the economy, but adding that he felt solid growth would soon resume.

Yet the day's economic reports suggested otherwise.

New home sales slumped 6.4 percent in July indicating the red-hot housing sector -- a major engine of growth -- is beginning to cool under the weight of higher interest rates.

U.S. orders for durable goods rose 1.7 percent in July when median forecasts had called for a 1.0 percent gain, but most of the rise was accounted for by a doubling of aircraft orders. Excluding the transportation sector, orders were up just 0.1 percent, well below what some analysts had expected.

Business investment was stronger, with core capital goods orders excluding aircraft and defense up 0.6 percent, but this was still a slowdown from lofty growth seen earlier this year.

"Ex-transport (durable goods) is only barely up, and the decline last month was only marginally revised, so it's a bit disappointing because it marks essentially the fourth month with no orders growth at all," said Chris Low, chief economist at FTN Financial.

"The bottom line is that there is a tremendous amount of corporate caution again, and very likely that's related to the price of oil," he added.

Oil prices have retreated considerably in recent days, slipping to $43.47 a barrel in New York on Wednesday from record highs near $50 last week.

DEMAND SHORTFALL

The $24 billion in new 2-year Treasury notes went at a high yield of 2.494 percent. It drew bids for 2.19 times the amount on offer, below July's 2.36 but in line with the 2.20 average for the year-to-date.

Indirect bidders, including customers of primary dealers and foreign central banks, picked up $10.46 billion or almost 43.6 percent of the whole issue. That was down from the huge 57 percent taken in the July auction and below the 48 percent average of the last five sales.

Primary dealers were left with $12.52 billion of the sale, paper they will likely be keen to unload ahead of next week's all-important August payrolls report. That prospect pushed the current two-year note (US2YT=RR: Quote, Profile, Research) 1/32 lower for a yield of 2.47 percent from 2.46 percent.

The five-year note (US5YT=RR: Quote, Profile, Research) was down 1/32 for a yield of 3.46 percent, while the 30-year bond (US30YT=RR: Quote, Profile, Research) added 4/32, lowering yields to 5.05 percent from 5.07 percent.

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