Good inflation news helped the long bond continue its streak of record low-yields yesterday, but the benchmark ended the session at slightly higher levels after a disappointing auction.

The 30-year long bond got whipped around yesterday ending down 6/32 to yield 6.43%, after sliding as low as 6.37% at midmorning. This is the lowest yield in the 16 years the Treasury has held regular bond auctions.

The long end of the market took it on the chin yesterday as an expected rush buyers failed to materialize for the Treasury's 30-year bond auction.

Meanwhile, short coupons benefited from retail and foreign buying on the back of good inflation news and turmoil in Eastern Europe.

Overall, the market's bullish tone remains in place, pending the release of the consumer price index today, traders said. The market expects the report to do little more than mirror the findings of yesterday's producer price index report.

Despite recent bullish price action and expectations for a stellar auction, the Treasury's sale of $11 billion in long bonds attracted mediocre demand.

The 30-year averaged 6.33%, with a two-point tail. The bid cover ratio was 2.23% and New York took 97.7% of the issue.

Reaction to the results was mixed. Some participants interpreted the auction results as acceptable, considering how far the market had rallied into the auction.

Others read the auction results as a sign that the market has reached the high end of recent ranges and is poised for a modest correction.

"Someone pulled the rug out from under the market," said one head trader at a primary dealership. "The results spooked the long end of the market and people unloaded some bonds."

The argument in support of buying the long end of the market remains the scarcity value of bonds as the Treasury begins issuing bonds on a semi-annual cycle. Traders said that the bright inflation picture and the sluggishness of growth in the economy have created an ideal environment for bonds and help stem selling in reaction to the disappointing auction.

That backdrop of positive fundamental and technical factors has lent support to the bond auction.

Traders said one reason why the auction failed to attract stronger bidding was the lack of short positions set for the issue. Few players were willing to short the market in light of how it has performed this week. Other traders said that the 6.33% coupon was too rich for investors and scared many away.

At the other side of the curve, the short end of the market benefited from a bout of safe-haven buying on reports that Bosnian Serb leader Radovan Karadzic threatened a nuclear strike against Europe. According to wire service reports, the Serbs warned that nuclear attacks on Europe would come in retaliation against Western intervention in Bosnia.

Short-dated paper was also supported by good news on inflation and the hope that a tighter stance on monetary policy will not be necessary. The long bond surged and lifted the rest of the market on news inflation and economic growth remain weak.

The Labor Department reported that July producer price index fell 0.2% overall and rose 0.1%, excluding food and energy. Most economists on the Street forecast an increase of 0.2% overall. PPI was dragged lower by a 1.0% drop in the energy component and a 0.5% decline in tobacco prices. Crude goods fell 1.3% overall and 0.6% core.

The good inflation report added to the market's bullish tone as economists generally agreed that there were few signs of upward price pressure, which helped quell fears of rising inflation among fix-income investors.

"The inflation numbers reinforce that the economy it too weak to raise demand," said Philip Braverman, chief economist at DKB Securities.

Braverman believes that the PPI release shows that Federal Reserve Chairman Alan Greenspan's warning about higher inflation and short-term interest rates were "unfounded" and "premature."

"We're seeing a moderation in inflation even with the wet weather and the river overflowing and the rise in commodity prices," he said. "After this report, the Fed has an egg on its face."

Steven Roach, senior economist at Morgan Stanley & Co., said the PPI report equalized the effects of higher inflation readings in the first five months of the year. "There's nothing in this report that's particularly disturbing and it's obvious that the price picture is emerging in good control."

In other data, the Labor Department reported a decline of 3,000 initial jobless claims for the week ended Aug. 7. Economists said that the jobless claims data were another supportive factor in the market's rise this morning.

"The total number of people out of work is actually higher because the four week moving average now stands at 353,500, up from last week," said Steven Ricchiuto, chief economist at Barclays de Zoete.

The Commerce Department also reported that retail sales rose 0.1% to $172.3 billion in July as auto sales tumbled. The latest report marks the fourth straight monthly gain in retail sales. Analyst had expected a small gain in total sales and weaker auto sales after a revised 0.2% increase in total retail sales in June, previously reported as a 0.4% gain.

Some economists said the sales figures were a positive development for the U.S. economy, as they showed that consumer spending patterns are beginning to gain steam.

"The message from the retail sales data is not one of great weakness," said Lynn Reaser, chief economist at First Interstate Bank of California. "Consumer spending is on a moderate track but it's not collapsing and there are significant signs in the data that the economy is not dead in the water like the bond market seems to think."

Reaser was encouraged by the fact that, compared to a year ago, total retail sales are up 6.1% and 5.2% excluding the volatile autos component.

Excluding autos, retail sales advanced 0.4% in July on the back of a 0.3% increase in June. The auto sales component fell 0.7% in the latest reporting period, following a revised 0.2% decline in June, previously reported as a 1.2% increase.

Jerry Zukowski, economist at Paine Webber Inc. also read strength into the retail sales figures. Particularly impressive, noted Zukowski, was the growth in the discretionary spending for July, which despite the softness of consumer confidence and weak income environment showed that there is some underlying strength in the consumer sector.

Sales at furniture stores gained 1.7% in July, following a revised 0.3% increase in June. Overall department store sales also advanced, gaining 1.4% in July after a smaller gain in June. Apparel and accessory stores posted the largest gain of 2.4% in July, following a 0.4% gain in June.

Despite the euphoria induced by the market's recent gains, some economists believe that the bond market got a bit ahead of itself today and expect a near-term correction in prices. Many believe that the detail of both the PPI and retail sales reports have been eclipsed by the bullish headlines.

"If the bond market likes these numbers today they're not going to like them in coming months," said Joseph Carson, chief economist at Dean Witter Reynolds. "The inflation outlook is good but not as good ads the market thinks."

Carson argued that much of the declines in PPI resulted from drops in food and gasoline prices and expects them to be reversed in coming months as the effects of flooding in the Midwest and newly implemented fuel taxes work their way through the economy.

The market gets the consumer price index today. Most economists forecast an increase of 0.2% for the overall report and for core CPI.

"If CPI also shows that inflation is well-controlled then the bond could do better," one head trader said. "If not we could have some problems."

In futures, the September contract ended down 9/32 to 115.31.

In the cash markets, the 4 1/4% two-year note was quoted late yesterday up 1/32 at 100.11-100.12 to yield 4.04%; the 5 1/4% five-year note ended down 1/32 at 100.16-100.18 to yield 5.12%; the 6 1/4% 10-year note was down 5/32 at 99.27-99.29 to yield 5.76%; and the 7 1/8% 30-year bond was down 6/32 at 109.00-109.02 to yield 6.43%.

The three-month Treasury bill was down one basis point at 3.06%; the six-month bill was down one basis point at 3.22%; and the year bill was down three basis points at 3.43%.Treasury Market Yields Prev. Prev. Thursday Week Month3-Month Bill 3.06 3.10 3.066-Month Bill 3.22 3.27 3.211-Year Bill 3.43 3.51 3.372-Year Note 4.04 4.10 3.953-Year Note 4.43 4.38 4.265-Year Note 5.12 5.15 4.977-Year Note 5.40 5.44 5.3210-Year Note 5.76 5.83 5.7030-Year Note 6.43 6.51 6.53Source: Cantor, Fitzgerald/Telerate

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