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Bonds Rally as Euro's Troubles Benefit Dollar

But a record pace of new home sales keeps short maturities from participating.

Unconfirmed rumors of problems with the euro boosted the dollar today, which gave the Treasury market a lift. But as stocks staged a huge rally and the November

new home sales

report shattered all sorts of records, the gains were concentrated in the benchmark 30-year bond.

Expectations as reported by


Short-maturity notes -- which lose ground when investors reallocate assets into stocks or when strong economic data quell hopes for interest-rate cuts by the


-- benefited only slightly.

Intermediate-maturity notes benefited mainly from the pricing of two large corporate bond issues. Such pricings can fuel demand for Treasuries, either as part of a hedging strategy, or from swap desks, which assume issuers' fixed-rate liabilities, and buy fixed-rate assets to manage their risk.

The long bond rose 14/32 to 101 2/32, dropping its yield 3 basis points to 5.18%. But the two-year Treasury note gained only 1/32, lowering its yield just 1 basis point to 4.63%. The difference between the two yields dropped to 55 basis points, from 57 on Tuesday.

Wednesday was the first day in which trades of euro-denominated assets could be settled, and that gave rise to rumors of problems, said David Gilmore, partner at

Foreign Exchange Analytics

. "I think there were some minor glitches, but there's no systemic settlement problem," he said.

Still, the rumors were enough to drop the euro through $1.167, the value at which it came into the world on Monday, and that accelerated its fall, to as low as $1.156 shortly after noon. It eventually recovered to around $1.160, but the squeeze quickly spread to the dollar-yen trade, where the dollar rallied to 112.95 yen from 111.36, Tuesday's 27-month low.

The long bond's price closely tracked the dollar for most of the day. "We're very much in dollar-watching mode," said Patrick Dimick, Treasury market strategist at

Warburg Dillon Read

. That's partly because of the euro's launch, he said, and partly because the yen's extreme strength recently is as threatening to the prospects for an Asian recovery as extreme yen weakness would be. A very strong yen makes Japanese products less affordable in other countries. "It's going to become a major problem for Asia if the yen keeps strengthening," he said.

The move was exaggerated,

Dresdner Kleinwort Benson

senior market economist Kevin Logan said, because so many investors were short the market. The negative sentiment was based on diminishing expectations for interest-rate cuts by the Fed and a weakening dollar against both the yen and the euro until today, he said.

Pricings of a $4 billion 10-year issue by

Fannie Mae


and a $2.3 billion 10-year issue by

Ford Motor Credit

, a


(F) - Get Free Report

unit, gave the 10-year Treasury note an early boost.

But shorter notes were hampered by stocks' heroic charge (the

Dow Jones Industrial Average

gained nearly 234 points), as well as by the November rise in the seasonally adjusted annual pace of new home sales to 965,000, an all-time high and a 7.6% gain over the revised October pace of 897,000. Economists surveyed by


had forecast a pace of 873,000.

The previous record high was June's 919,000 pace. In addition, with the November numbers, 1998 has surpassed 1977 as the year in which the most new homes were sold. The 1977 total was 819,000.

Although unseasonably warm weather presumably accelerated the November pace, bond investors fear that a high level of new home sales will continue to support a high level of consumer spending on furniture and other durable goods, possibly helping to sustain an above-trend rate of economic growth.

Expectations as reported by