The difference between short and long Treasury yields widened sharply today as dropping stock prices and the prospect that

NATO

will soon start bombing Yugoslavia fueled demand for short-dated issues, while the sale of the largest-ever corporate bond issue by

AT&T

(T) - Get Report

stood in the way of greater gains by the long end.

The benchmark 30-year Treasury bond ended the day up 5/32 at 95 16/32, dropping its yield a basis point to 5.56%. But the two-year Treasury note, for which the same change in price produces a much larger change in yield, also rallied 5/32, dropping its yield 9 basis points to 4.98%. The yield spread between the two issues, a popular measure of the slope of the yield curve, widened from 50 basis points to 58 basis points, the steepest since Feb. 10.

"All things being equal, it would have been a down day, but we've been able to digest the

AT&T-related selling better because stocks sold off so hard," said John Burgess, head of fixed income at

Bankers Trust

.

The long end also benefited from a $675 billion coupon pass by the

Fed

. In a coupon pass, the Fed buys securities in order to inject enough liquidity into the banking system to keep the fed funds rate on target. In today's pass, the Fed bought long-dated securities maturing from 2022 to 2027.

The AT&T deal was the focus for much of the day. Although the long bond traded in only a 20/32 range, the deal forced Treasury prices lower at two junctures. First at around 10 a.m. EST, when the company announced it was increasing the size of the deal to $8 billion from $7 billion. And again when the bonds were priced at around 12:45 p.m EST. The effect was disproportionately on long Treasuries because it was a long deal, comprising a $3 billion 30-year issue, a $3 billion 10-year issue and a $2 billion 10-year issue.

Investors presumably lightened their holdings of Treasuries in order to buy a piece of the AT&T deal, which as the largest-ever corporate bond is expected to be a highly liquid benchmark -- a feature for which buyers can be expected to pay up. That trend overwhelmed any buying of Treasuries that may have occurred as underwriters covered short positions established to guard the deal against a sudden rise in interest rates.

Previously,

MCI WorldCom

(WCOM)

held the record for the largest-ever corporate bond, having done a $6.1 billion deal last summer.

But while the AT&T bond trapped the long end of the yield curve, short-maturity instruments rallied strongly as last-ditch U.S. diplomatic efforts to end Serbian aggression in the Yugoslav province of Kosovo failed and the

Dow Jones Industrial Average

tumbled more than 200 points to close at a three-week low. Short maturities generally benefit most from flight-to-quality buying because relative to long-dated paper, they carry little interest-rate risk. They're the quintessential parking place.

"It looks like we're going to start dropping bombs any minute now, so it's not surprising to see the front end improving," said Bill Hornbarger, Treasury market strategist at

A.G. Edwards

in St. Louis.

Today's rise in prices muddies the water for tomorrow's monthly auction of two-year Treasury notes. The Treasury will take bids on $15 billion of new securities through 1 p.m. EST and announce results at around 1:30 p.m EST. In recent days, market watchers have been saying that a yield of at least 5% on the two-year note was necessary for a "good" auction with plenty of bidders. A good auction sets a positive tone for future trading, while a poor auction can weigh on the market for days to come.