The Treasury market rallied yesterday on the unexpectedly weak housing starts report, but the long bond's gains lagged those of other securities, reflecting traders' worries about tax cuts.

Late yesterday, short- and intermediate-term notes were up 1/8 to 1/2 point, and the 30-year bond was up 3/8, to yield 7.32%.

"The market was very, very firm after the housing number," the head of a government trading desk said. "We saw, good buying through the 10-year sector."

The 2.8% decline in July housing starts Provided more evidence of the economy's lassitude and encouraged speculation that the Federal Reserve will cut interest rates again.

But as the market rallied, the long bond trailed the rest of the market, and the yield curve steepened.

Traders said investors are buying short-term paper in hopes of another Fed easing and moving out to intermediate notes if they want higher yields, but are continuing to avoid long-term paper.

"People are scared silly of long bonds," a government note trader said.

Investors are worried that long-term prices will suffer if pro-growth proposals from either political party result in a stronger economy and higher inflation.

"People are very nervous about what [president George] Bush will say Thursday night" in his acceptance speech at the Republican National Convention, the desk head said.

Richard Darman, director of Office of Management and Budget, said yesterday that the President's acceptance speech would contain "some new things."

Long-term traders are also concerned that a corruption scandal in Brazil could derail the nation, s debt reduction deal. Brazil's debt reduction bonds were to be collateralized with Treasury strips.

The head of a Brazilian parliamentary committee investigating the scandal said yesterday that he expected President Fernando Collor de Mello to go on trial.

Short-term Treasury prices actually began to improve in overseastrading, and analysts said some of

that was due to another big drop in Japanese stock prices.

The Nikkei index fell 620.14 points, or 4.12%, to 14,309.41, its lowest close in over six years.

The Treasury market improved more in early New York trading after the housing starts report came out. The 2.8% decline, to a 1.119 million annual rate, contrasted with the consensus forecast for a 2.8% gain, to a 1.2 million annual pace.

June's decline was revised down to a 3.7% drop from the 3.2% decline originally reported.

Carol Stone, a senior economist at Nomura Securities International, said the July starts showed that "it takes more than declining mortgage rates - it takes consumers who are confident and banks who are willing lenders."

The only positive number was the 3.7% gain in permits, to a 1.07 million annual rate, which was the first increase in permits in five months.

But Steven Ricchiuto, chief economist at Barclays de Zoete Wedd Securities, pointed out that most of the gain was in the volatile multifamily area, rather than in single-family permits.

"This is not the kind of number the Fed's going to be comfortable with," Mr. Ricchiuto said if the port as a whole.

He does not expect any immediate change in policy, but said the starts number adds to the evidence supporting a Fed bias toward easing.

Ms. Stone said she expected Fed policymakers to adopt a directive at yesterday's Federal Open Market Committee meeting that is biased toward easing, but said it would take "real signs of distinctive weakness" before they cut rates again.

She added that in any case, Fed policymakers would probably be reluctant to ease policy during the Republican National Convention for fear the move would be interpreted as political.

Some traders hoped there might even be a move at Fed time yesterday, but analysts said the Fed's addition of funds with two-day system repurchase agreements had no policy significance.

After trading quietly for most of the afternoon, Treasury prices dipped near the close of futures on reports that the weekly Johnson Redbook said department store sales were down 0.4% on a seasonally adjusted basis during the first half of August. That is stronger than the 2.6% decline the Redbook survey found in the first week of August.

The September bond futures contract closed 17/32 higher at 106 1/32.

In the cash market, the 7 1/4% 30-year bond was 3/8 higher, at 98 30/32- 99 2/32, to yield 7.32%.

The 6 3/8% 10-year note rose 14/32, to 99 6/32-99 10/32, to yield 6.47%.

The three-year 4 5/8% note was up 7/32, at 100 5/32-100 7/32, to yield 4.54%.

Rates on Treasury bills were lower, with the three-month bill down two basis points at 3.08%, the six-month bill off four basis points at 3.14%, and the year bill four basis points lower at 3.22%.

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