The Treasury market sold off sharply yesterday when an unexpectedly large increase in September consumer prices put traders' easing hopes on hold and reawakening inflation worries at the long end.

After posting big losses during the morning, prices declined even more yesterday afternoon when all three measures of the money supply showed healthy gains.

By late in the day, the 30-year bond was off 1 5/8 points and yielded 8.02%. It was the first time in five weeks that the bellwether bond had ended above 8%.

Treasury Market Yields

Prev. Prev.

Thursday Week Month

3-Month Bill 5.20 5.14 5.33

6-Month Bill 5.32 5.25 5.46

1-Year Bill 5.40 5.36 5.54

2-Year Note 5.95 5.95 6.16

3-Year Note 6.22 6.22 6.41

4-Year Note 6.34 6.41 6.61

5-Year Note 6.92 6.90 7.07

7-Year Note 7.26 7.28 7.40

10-Year Note 7.56 7.55 7.60

15-Year Bond 7.86 7.82 7.84

30-Year Bond 8.02 7.95 7.91

Source: Cantor, Fitzgerald/Telerate

"Eight percent was awfully difficult to get through, the first three times we tried," said Steven Wood, director of financial markets research at Bank of America. "Now that we're back above it, we may be setting ourselves a new florr.

Most analysts said the unfriendly inflation news would delay a cut in interest rates by the Federal Reserve. But they still expect the Fed will have to ease eventually to spur the sagging economy.

September consumer prices rose 0.4%, as did the core rate of inflation, excluding food and energy prices. Economists had forecast a 0.2% increase overall and a 0.3% gain in the core rate.

The core rate was particularly disturbing because September was the fourth month in a row that measure has come in at 0.4%.

"The market's reaction was, inflation is more a problem than we thought," Mr. Wood said. "Since people were long, expecting a good number and a Fed ease, they decided to reassess their positions and bailed out."

The component that pushed prices higher was a 0.5% increase in housing costs, which count for 40% of the consumer price index.

Stephen Gallagher, an economists at Kidder, Peabody & Co., said the bigger than-expected increase in consumer prices meant a couple of weeks' delay before the Fed would consider cutting interest rates. He said an easing move might occur after the October employment report is released Nov. 1.

Many traders had expected favorable numbers yesterday and thought the Fed might ease yesterday or today.

Ram Bhagavatula, chief economist at Citibank, said the combination of the jump in consumer prices and yesterday's bigger-than-expected decline in jobless claims showed the Fed does not need to ease at all.

The jobless claims fell 13,000, to 423,000, when the market had expected claims to stay around last week's level.

"The Fed has been contending that the underlying fundamentals are strong and his proves that point," Mr. Bhagavatula said. "This gives the Fed feedback that the 5 1/4% funds rate is not inappropriate.

Other numbers released yesterday included the August trade deficit and September industrial output.

The trade deficit widened to $6.76 billion in August from a revised $5.95 billion in July as both imports and exports declined. And last month's industrial production increased a scant 0.1%, following a lackluster 0.2% rise in August, as declines in utility usage and mining output offset the gains in manufacturing.

Henry Engler, an economist at Chemical Securities, said the trade and industrial production reports showed weakness, not strength.

"If you look at all the reports we had, they suggest an economy that's still relatively weak," Mr. Engler said. "I'm still inclined to think the odds favor an ease, but we may have to wait until the next employment report."

The final straw for the bond market yesterday was the news that the money supply numbers had risen.

Economists had expected another week of declines in the monetary aggregates. Instead, the key M2 measure rose $4.5 billion, to $3.4 trillion, while M1 increased $700 million, to $875.8 billion, and and M3 surged $5.6 billion, to $4.2 trillion.

The improvement in money supply gives the Federal Reserve another reason to postpone any change in monetary policy.

Traders said most of yesterday's activity occurred after the morning's numbers, with another spurt of trades near the close of futures and again after the money supply numbers.

Even though prices backed off all along the curve, traders said the real problem is still the long bond.

Bonds have been hurt in recent weeks by the steady selling of Treasury Strips by Japanese investors. Not only does that selling put pressure on long-term prices now, a coupon trader said yesterday, it also suggests that if Japanese investors have stopped investing in Strips, there will be less demand when the Treasury sells bonds again next month.

The trader noted that the long bond now yields 46 basis points more than the 10[year note, up from a spread of about 20 at the time of the August refunding. "The bond has not enjoyed any great sponsorship at all and when you get news like today, [suggesting] inflation fears, it loses more of its glow," he said.

The December bond future contract closed 1 1/4 points lower at 98 20/32.

In the cash market, the 30-year 8 1/8% bond was 1 21/32 lower, at 101 1/32-101 5/32, to yeidl 8.02%.

The 7 7/8% 10-year note fell 29/32, to 102-102 4/32, to yield 7.56%.

The three-year 6 7/8% note was down 9/32, at 101 19/32-101 21/32, to yeild 6.22%.

In when-issued trading, the two-year note to be sold Tuesday was bid at 6.01% and the five-year note to be auctioned Wednesday stood at 6.95%.

Rates on Treasury bills were higher, with the three-month bill up 10 basis points at 5.07%, the six-month bill up 11 basis points at 5.12%, and the year bill 13 basis points higher at 5.40%.

Economists surveyed by The Bond Buyer on average expect this morning's September housing starts to come in at a 1.07 million annual rate, unchanged from the pace in August.

The forecasts ranged from a low of 1.02 million to a high of 1.10 million.

Economists with forecasts at the low end say the 5% drop in August permits suggests starts declined in September. And those with optimistic forecasts expect September starts to respond to the substantial decline in interest rates that occurred last month.

In other news, for the week ending Wednesday, the federal funds rate averaged 5.28%, up from 5.19% the previous week, according to the New York Fed.

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