Inflation fears push yields up; long bond rate holds below 6%.

The Treasury market caved in yesterday as disappointing news on inflation brought the rally to a grinding halt.

The market's performance reinforced the consolidative trend that emerged last week and left investors to question the value of Treasury instruments at current yield levels.

The 30-year bond ended down almost 1 1/2 points yesterday, to yield 5.97%.

A larger-than-expected jump in consumer prices, coupled with an increase in retail sales, sent shock waves through the market and ignited the sharp sell-off.

While the inflation numbers were not all that bad for the bond market, many participants had become overly confident that price pressures were falling, and most were looking for a number closer to unchanged.

Retail accounts came off the sidelines to unload securities purchased in recent weeks, reinforcing last week's message that the long bond is not immune to bad news.

Market observers said the consumer price index report, which rose 0.3% in August, cast an element of uncertainty into the health of Treasuries because the market's recent rally was based primarily on the belief that inflation was moderating and that the economy was weakening further.

But reports released yesterday were in direct opposition with that view. While price action yesterday does not mean that the recent bullish trend in Treasuries is over, participants said it does hamper the market's ability to extend recent gains.

"The market rallied in hope that inflation would slow down and further gains are no longer justified for now," said Charles Lieberman, director of financial markets research at Chemical Securities.

While the consumer price index dealt the market a sobering blow, participants said the price declines were generally corrective in nature, as many participants had grown weary of the market's lofty levels and the belief that the market had risen too far, too fast.

With long-term yields to their lowest levels in 25 years, many accounts used yesterday's weakening trend in prices to lighten inventories.

Economists were as surprised as anyone by the CPI report. But they generally agreed that the jump in prices was caused by one-time seasonal factors and that the inflation pressures remain subdued. Much of the increase in consumer prices were related to increases in prices for apparel, shelter, and foods.

Marilyn Schaja, money market economist at Donaldson, Lufkin & Jenrette Securities Corp., said the reports show that modest inflationary pressures exist in the economy, which fits with a 2.5% inflation rate on an annualized basis.

"This report confirms that inflation still exists and that we're not in a deflationary environment," Schaja said. "For the most part, it's still supportive for the market."

The Commerce Department reported that retail sales rose 0.2% in August, helped mostly by strong auto sales in the month.

Mary Dennis, economist at Merrill Lynch Government Securities, said the report was consistent with other signs of moderate growth in the real economy.

Market analysts said upbeat news on the economy, released yesterday, was underscored by comments by a central bank official.

Speaking in Washington, J. Alfred Broaddus, president of the Federal Reserve Bank of Richmond, said he expects the economic recovery to continue for some time and is hopeful about further progress in fighting inflation.

Particularly interesting to market economists was his prediction that gross domestic product growth would well exceed expectations in the third and fourth quarters of the year.

With the state of economic and market fundamentals in question, participants said upcoming economic indicators have taken on increased significance.

"Data will be important because the market needs further impetus to get going again." said Dana Johnson, head of market analysis at First Chicago Corp.

Johnson believes that recent economic reports have dashed all hopes of a cut in interest rates and hurt prospects, for further gains, particularly at the short end of the curve. He said the long end of the curve is likely to establish a new trading range near the psychologically important 6% yield until the market receives further evidence that the economic and inflationary growth remain weak.

The market had a lot of reasons to rally over recent weeks," Johnson said. "In general, those reasons are still in place but the market will consolidate somewhat first."

In futures, the September contract ended down almost 3 1/2 points to 120.19. Treasury Market Yields Prev. Prev. Tuesday Week Month3-Month Bill 3.03 2.98 3.066-Month Bill 3.16 3.12 3.201 -Year Bill 3.36 3.25 3.392-Year Note 3.89 3.72 3.983-Year Note 4.20 4.03 4.375-Year Note 4.77 4.61 5.067-Year Note 4.97 4.85 5.3410-Year Note 5.38 5,26 5.7030-Year Bond 5.97 5.89 6.30Source: Cantor, Fitzgerald/Telerate

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