After suffering a sharp correction in midweek, Treasury prices bounced back Friday when the market got good inflation news.
The 30-year bond closed almost a point higher, where it yielded 7.88%.
Analysts said last week's statistics, including Friday's favorable September producer prices and lackluster retail sales and Thursday's weak money supply numbers, leave the way clear for another easing by the Federal Reserve.
Even though the Fed indicated Friday that it had not changed policy, traders said the move could come as early as tomorrow.
"Between Tueday and Thurdsay, they'll go 25 points for sure," said Lawrence Krohn, a senior economist at Lehman Brothers.
The short end is likely to benefit most if the Federal Reserve does cut the funds target another 25 basis points.
But some economists said the improvement in inflation apparent in Friday's producer price report could have a more dramatic impact on long-term prices if participants respond by factoring out some of the inflation premium that has long been built into long-term
September producer prices rose only 0.1%, and the core rate of inflation, minus food and energy costs, was flat.
Robert Brusca, chief economist at Nikko Securities, said now that the improvement in inflation is clear, bond prices will go up so fast that traders had better buckle their seat belts.
"We're going to see [30-year] yields fall to 7 1/4% by the end of the year," Mr. Brusca said.
He added that the improvement in inflation was broad-based and not simply a reflection of sharp declines in oil prices, as was the case in 1986 and 1987.
The Treasury curve steepened more last week, with the 30-year yielding 200 basis points more than the two-year late Friday. Mr. Brusaca expects the yield curve to flatten as the long end outperforms short-term prices.
Thomas Sowanick, a senior fixed-income strategist at Merrill Lynch, argued precisely the opposite point in a market letter Friday.
Mr. Sowanick said the 30-year could end up yielding as much as 250 basis points more that the two-year as the market undergoes a "fundamental revaluation."
"The market was held technically flat between 1985 and 1990 because of a large demand for stripping despite the growing size of the Treasury's deficits," he said.
As the market enters the 1990s, the demand for zeros is falling and Treasury issuance is growing, forcing a shift in the curve, Mr. Sowanick said.
He suggested trading strategies that "exploit riding down the curve," and said the seven-year note offers the "best relative value."
Even though prices posted healthy gains Friday, traders sounded cautious, and some said the market's advance may be hampered in coming weeks by upcoming supply.
Treasury issuance is on its way. On Wednesday, the government will announce next week's two-year and five-year auctions. And once that papper is out of the way, the market can start worrying about the three- and 10-year notes and 30-year bonds to be sold at the quarterly refunding early next month.
Another supply problem recently stemmed from reports that Japanese investors were selling Treasury Strips. Analysts said the selling should stop now that the Japanese are past the midway point in their fiscal year.
The focus this week will be on watching the Fed. Thursday's consumer price report will also be important, with analysts expecting an increase of about 0.2%.
David Blitzer, chief economist at Standard & Poor's Corp., was less optimistic than other analysts about getting another cut in rates within the next week.
Although the inflation news was good, he said there were some signs of economic strenght in the retail sales report, including an increase in general merchandise sales.
Given those hints of revival, Mr. Blitzer said the Fed would prefer to wait until the next employment report in early November before easing policy again.
Analysts did not expect the G-7 meeting over the weekend to have any impact on the Treasury market.
Mr. Blitzer said that over the last year or two, the various nations have put domestic considerations first when making monetary policy, which has prevented coordinated interest rate moves.
"They would rather concentrate on the domestic issues," he said. "I think that general attitude is still in place."
Treasury prices closed Friday's shortened trading session at the day's highs, with the 30-year bond up 15/32 to yield 7.88%.
The Public Securities Association recommended that the cash government market close at 2 p.m., eastern daylight time, Friday, ahead of the three-day weekend. The market is closed today for Columbus Day.
Treasury prices began to improve in overseas trading, and then rallied sharply on the producer price and retail sales data.
September producer prices rose 0.1% when the market expected a 0.2% gain, and the core rate, excluding food and energy prices, was flat -- much better than the consensus forecast of a 0.3% increase.
Meanwhile, September retail sales rose 0.7%, which was a little stronger than expected, but almost all the strength came from cars. Excluding autos, sales rose only 0.1%.
"non-auto sales were anemic," said Matthew Alexy, a money market at Deutsche Bank. "The consumer definitely remains cautious, and the inflation news is encouraging."
Mr. Krohn said the weakness in producer prices also shows soft demand. Together, the numbers "really suggest the recovery is going to continue to be subsued," he said.
Prices dipped at midday after the Fed drained reserves with matched sales for the third day in a row, signaling that it was still targeting a 5 1/4% funs rate, then recovered toward the close.
The December bond future contract closed 1 1/4 points higher at 99 28/32.
In the cash market, the 30-year 8 1/8 bond was 15/16 higher, at 102 21/32-102 25/32, to yield 7.88%.
The 7 7/8% 10-year note rose 11/16 to 102 23/32-102 27/32, to yield 7.45%.
The three-year 6 7/8% note was up 7/22, at 101 26/32-101 28/32, to yield 6.14%.
In when-issued trading, the 7 1/8% seven-year notes were 5/8 higher, at 99 21/32-99 25/32, and yielded 7.16%, down from the 7.20% average at Wednesday's auction.
Rates on Treasury bills were lower, with the three-month bill down six basis points at 4.96%, the six-month off five basis points at 5.01%, and the year bill six basis points lower at 5.03%.