FINANCIAL MARKETS : Bond Yields Plunge, Stocks Gain on News of Slowing Economy

Treasury bond yields fell dramatically Tuesday as optimism about lower interest rates and lower inflation was stoked by economic data.

The news also sent stocks broadly higher, pushing several key indexes to record highs. The Dow industrials surged 38.05 points to 4,484.51.

The government’s report of weak retail sales in May and a decline in consumer inflation restarted bonds’ 1995 rally, as more investors and traders became convinced that the economy is fading enough to warrant an official cut in interest rates by the Federal Reserve Board.

“People were expecting retail sales to be a lot stronger,� said Patrick Retzer, who manages the $68-million Heartland U.S. Government Securities Fund in Milwaukee. “It’s a perfect world again. The skies have cleared, and the next Fed move will be an easing� in interest rates, he said.

As buyers poured into bonds, yields on some maturities posted their biggest one-day declines in five years.

The two-year Treasury note yield, for example, plunged 0.32 percentage point, from 5.95% Monday to 5.63% on Tuesday.

The 30-year T-bond yield dropped to 6.54% from 6.70% on Monday.

Last week, expectations for a rate cut were deflated by comments by Fed Chairman Alan Greenspan that suggested the economy was not headed for a prolonged downturn.

Yet bond traders all but forgot those comments on Tuesday.

In the stock market, meanwhile, the Dow closed just shy of its previous closing record of 4,485.20 set June 6.

“Profits count,� said Larry Wachtel, a market analyst at Prudential Securities, “but rates rule the roost.�

“The market is a forward looking mechanism and it sees a rate reduction coming,� said David Aushwitz, president of Arnold Investment Counsel, which manages about $100 million in assets. “The market is a better judge than you and I on the direction of rates -- it sets the pace for the Federal Reserve.�

The Nasdaq composite index rose 6.25 points to 894.23, topping its record closing of 887.98 set Monday. The Standard & Poor’s 500-stock index advanced 5.17 to 536.05 points, above its record of 535.60 set the previous Monday.

On the New York Stock Exchange, advancing issues led decliners by about 11 to 5 in active trading.

Among Tuesday’s market highlights:

* Banking and utility stocks rocketed as interest rates fell. Citicorp climbed 2 7/8 to 55 7/8 and BankAmerica gained 1 1/4 to 52 5/8..

* Airline stocks rose after major carriers indicated that fares will remain firm, despite cuts for the July 4 holiday. Delta surged 3 5/8 to 73 3/8. The run in airline stocks pushed the Dow transportation index up 37.73 points, or 2.27%, to 1,700.95.

* Among other issues, ITT soared 5 5/8 to 114 7/8 after the company said it will spin off its businesses, with combined revenues of $25 billion, into three publicly held companies in one of the biggest corporate restructurings ever.

* In overseas stock markets, the Nikkei 225-share average in Tokyo fell 1.44% in overnight trading, while Frankfurt’s DAX index lost 0.21%. But the FTSE-100 index in London added 0.10%.

* The dollar rose against most currencies, buoyed by the U.S. rally and news that President Clinton was offering a plan to curb the budget deficit. In late New York trading, the dollar was quoted at 84.63 Japanese yen, up from 84.04 on Monday. It was also changing hands in New York at 1.4085 German marks, up from 1.4023.

* Coffee prices plummeted to the lowest level in a year in anticipation of a U.S. government report on the size of the Brazilian coffee crop, which had been damaged a year ago by frost and drought. Although the report projected Brazil’s 1995-96 coffee production at two-thirds the size of the previous year’s crop, world demand has declined as supply estimates have improved.

On Tuesday, July coffee fell 7.15 cents to 146.45 cents a pound, after earlier hitting a low of 145.60 cents--its lowest since June 28, 1994.