As proposals for cutting taxes gained momentum in the nation's capital yesterday, the Treasury market responded with another big drop in prices.

The bond market is worried that tax cuts will boost the federal deficit and thus the supply of Treasury securities. Traders are also concerned that measures to stimulate the economy could wind up adding to inflationary pressures.

Late in the afternoon, the 30-year bond was off 1 3/8 points to yield 8.07%.

Although yesterday's sell-off did not match the 1 5/8-point plunge at the long end Thursday on the unexpectedly large increase in September consumer prices, it more than erased Friday's rebound in prices. The bellwether bond's 8.07% closing yield yesterday was the highest since early September.

William Sullivan, director of money market research at Dean Witter Reynolds Inc., said it was not surprising that prices had declined yesterday since the market was "somewhat over-bought coming off of Friday's sharp gains.

"But prices were pushed even lower by the news that there seems to be an escalation in discussion in Washington, D.C., among elected officials regarding the need for fiscal stimulus," Mr. Sullivan said.

"The economy is clearly becoming an election-year issue," he added. "Both parties want to show leadership when it comes to the overall economy, and fear is developing that fiscal prudence will be thrown to the wind."

Over the weekend, Sen. Lloyd Bentsen, D-Tex., proposed the government cut taxes by $72.5 billion over the next five years by giving taxpayers credits for children and allowing everyone to open individual retirement accounts.

Administration officials had been talking about a growth package that included cuts in the capital gains tax. But yesterday, Marlin Fitzwater, the White House spokesman, responded to Sen. Bentsen's plan by saying the administration is also considering reducing taxes for middle-class taxpayers.

Mr. Sullivan said the White House's quick attempt to match Sen. Bentsen "shows me we've entered the realm of politics and left the realm of economics behind us."

Although the administration's plan differs from Sen. Bentsen's, the fact that both sides are in favor of growth measures suggests some package will eventually be enacted.

Traders questioned how much the various plans would do to aid the economy and seemed to think the most likely effect of the tax cuts would be to worsen the deficit.

Sen. Bentsen plans to offset lost

Treasury Market Yields

Pref. Prev.

Monday Week Month

3-Month Bill 5.18 NA 5.34

6-Month Bill 5.31 NA 5.45

1-Year Bill 5.42 NA 5.51

2-Year Note 5.96 5.86 6.12

3-Year Note 6.23 6.12 6.35

4-Year Note 6.39 6.30 6.57

5-Year Note 6.95 6.80 7.05

7-Year Note 7.31 7.16 7.34

10-Year Note 7.62 7.45 7.53

15-Year Bond 7.89 7.72 7.80

30-Year Bond 8.07 7.87 7.87

Source: Cantor, Fitzgerald/Telerate

revenues by cutting military spending, and the White House has also said its proposals would not add to the deficit. But traders yesterday derided the idea that tax cuts would be "revenue neutral," as they say in Washington.

As the long end deteriorated yesterday, short-term prices declined at a slower pace, and as a consequence, the yield curve steepened further.

Traders said that even though talk of tax cuts predominated yesterday, the long end has been ailing for a long time. Its problems include inflation fears, which were revived by last week's consumer price report and worries about supply.

The market faces note auctions this week, including $13.5 billion of two-year notes tomorrow and $9 billion of five-year notes Thursday, and then dealers must prepare to bid on the quarterly refunding early next month.

Traders said top-heavy positions were also a factor in yesterday's rout.

"Everybody was long, and now they're getting crushed," a bond trader said.

After Thursday's disappointing CPI report, the market retraced some of those losses on Friday.

When the market failed to follow up Friday's gains this morning, "you started breaking some support levels and away you went," the trader said.

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

In the cash market, the 30-year 8 1/8% bond was 1 13/32 lower, at 100 15/32-100 129/32, to yield 8.07%.

The 7 7/8% 10-year note fell 27/32, to 101 19/32-101 23/32, to yield 7.62%.

The three-year 6 7/8% 10-year note was down 7/32, at 101 18/32-101 20/32, to yield 6.23%.

In when-issued trading, the two-year note to be sold tomorrow was offered at 5.99%, and the five-year note to be auctioned Thursday stood at 6.94%.

Rates on Treasury bills were higher, with the three-month bill up three basis points at 5.06%, the six-month bill up seven basis points at 5.12%, and the year bill six basis points higher at 5.15%.

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