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Tumbling stock prices stoked demand for

Treasury securities, returning the benchmark 10-year note's yield to its lowest level of the year, dropping the five-year note's yield to a fresh low for the year.

Falling stock prices increase demand for Treasuries from the standpoint that bonds hold their value more reliably than stocks, and because falling stock prices are seen as an indicator that economic growth will slow, allowing interest rates to fall and bond prices to rise.

The benchmark 10-year

Treasury note rose 11/32 to 100 15/32, dropping its yield 5.2 basis points to 5.684%, even with its best close of the year on Sept. 3.

Shorter-maturity issues did even better, as they typically do in rallies driven by falling stock prices. When people are buying Treasuries in response to weakness in stocks, they normally buy the most liquid issues, which are the shortest-maturity ones. The five-year note gained 9/32, dropping its yield 7.1 basis points to 5.673%, the lowest since September 1999. And the two-year note rose 3/32 to 100 9/32, lowering its yield 6 basis points to 5.835%.

The outperformance of the five-year note is a function of the steepening

yield curve, said Jim Kochan, senior bond strategist at

Robert W. Baird

in Milwaukee. When the yield curve is flattening, as it did for most of the year, bond investors get the best performance from a combination of very short- and very long-maturity issues. But when the curve is steepening, as it as been lately, the best performance comes from the five-year note.

The 30-year

Treasury bond added 18/32 to 106 25/32, dropping its yield 4.5 basis points to 5.768%.

At the

Chicago Board of Trade

, the December

Treasury futures contract gained 24/32 to 100 3/32.

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With no big surprises from the economic calendar (the day's only major report,

industrial production


definition |

chart |


) for September, looked pretty much the way economists expected it to), the action in the stock market was the principal driver of the action in bonds, market analysts said.

"There's no question that a preference for safety and liquidity is still very much alive and well with respect to Treasury securities,"

Morgan Stanley Dean Witter

fixed-income strategist Kevin Flanagan said. "Once again we see people moving into the comfort and safety of the U.S. Treasuries market."

Falling stock prices are seen as likely to slow economic growth by making consumers feel less inclined to spend money. That reasoning was also reflected in the

fed funds futures market, where traders discounted higher odds that the

Fed will cut interest rates by the end of the first quarter. As measured by the April fed funds contract, the odds of a cut in the rate to 6.25% from 6.5% currently rose to 78%, a new high.

Flanagan sees that as "a knee-jerk response that's probably not warranted at this stage."

Kochan agrees. "In my mind there are no signs the economy is headed toward recession," he said. "I'd be selling the Treasury market here."

Treasury prices have been driven higher over the last several weeks by little more than the action in stocks, Kochan says. If the October selloff proves to be merely an October selloff, and not the start of something longer and more painful, "the bond market is going to have to find something else to sustain a rally, and I'm not sure it can find that."

Economic Indicators

Retail sales data were quite strong.


BTM Weekly U.S. Retail Chain Store Sales Index


definition |

chart ) rose a solid 0.5%, its largest gain since May. The

Redbook Retail Average


definition |

chart ) found October sales running 0.8% ahead of September after two weeks, slightly ahead of target.


industrial production


definition |

chart |


) rose only 0.2% in September, while capacity utilization held steady at 82.2%. The average increase in industrial production was just 0.1% during the third quarter, down from an average of 0.6% during the first six months of the year.

Finally, the

Housing Market Index


definition |

chart |


) ticked up to 63 in October from 61 in September.

Currency and Commodities

The dollar was little changed against the yen and lower against the euro. It lately was worth 108.00 yen, down from 108.02. The euro was worth $0.8550, up from $0.8506. For more on currencies, see


Currencies column.

Crude oil for November delivery at the

New York Mercantile Exchange

rose to $33.08 per barrel from $32.92.


Bridge Commodity Research Bureau Index

rose to 229.92 from 229.59.

Gold for December delivery at the


fell to $273.40 per ounce from $273.90.