A better forecast for inflation and sluggish economic growth should provide the Treasury market with solid support this week, analysts say.

The 30-year bond ended Friday Up 2/32 to yield 6.56%, its lowest level in eight days.

The preliminary report on second-quarter gross domestic product showed that economic and inflationary growth remain weak and dimmed prospects for a near-term tightening of monetary policy.

The news revived interest in Treasuries on many fronts and gave prices a much needed lift. Retail accounts came off the sidelines and foreign investors moved money out of Europe and into the short end of the U.S. bond market.

Analysts believe those developments will keep the market well supported this week.

But as the market enters into a period of consolidation, the spotlight is on three key factors: the budget debate, the employment report, and the quarterly refunding.

"Despite the market's impressive performance, this week is the real test," said Samual Kahan, chief economist at Fuji Securities in Chicago.

Word from the White House is that President Clinton's budget deficit package will get the Congressional stamp of approval this week. Comments by House Ways and Means Committee Chairman Dan Rostenkowski about near-term passage helped allay the market's fears that the negotiations had stalled.

Treasuries are expected to maintain a solid bid going into the jobs report, which will provide the market with its first comprehensive view of economic activity in July. Expectations for the report, slated for release on Friday, center on an increase of 175,000 non-farm payroll jobs.

The report has taken on increased significance this week as the market enters a period of supply and becomes more vulnerable to bad news.

"The fear is that the numbers will put pressure on the market going into the refunding," Kahan said. "The refunding will help the the market's tone for the next few weeks."

The Treasury Department will announce the size of the refunding package on Wednesday. Most analysts think the size will be $38 billion - $16.5 billion in three-year notes, $11 billion in 10-year notes, and $10.5 billion in bonds.

On the international front, continued turmoil in the European Exchange Rate Mechanism and the stable U.S. dollar should also provide solid support for Treasuries as foreign investors try to insulate themselves from currency risk. As a result, foreign investors continue to move money out of Europe and into the short end of the U.S. bond market.

Michael Strauss, chief economist at Yamaichi Securities, said that events abroad will dominate activity at the front end of the yield curve, which has been the chief beneficiary of the flight to quality.

One side effect of the currency crisis has been the sharp increase in gold prices. But the market managed to shrug off the surge because it was driven purely by the ERM crisis and not inflationary expectations, Strauss said.

Activity Friday started on a firm note following the release of a number of economic reports.

A few sellers keyed off an 11% rise in single-family home sales in June. Those looking to lighten inventories also looked to the personal income and spending numbers, which were unchanged and up 0.6%, respectively.

The data supplied trading impetus for players on both sides of the market, but consensus quickly emerged that the reports supported the market's view that the economy remains on a slow growth path.

"The market was up and down, but it seems that most people have interpreted the data as generally positive for the market," said James Kenney, fixed-income trading manager at Prudential Securities.

Buyers discounted the home sales release, arguing that it merely supported the findings of recent mortgage surveys, including those conducted by the Mortgage Bankers Association.

Lyle Gramley, consulting economist at the Mortgage Bankers Association and a former Federal Reserve Governor, read the home sales report as a further indication that the housing sector is doing better on the year, but remains sluggish nonetheless.

"Despite this morning's report, I'm disappointed that we haven't had a bigger jump in sales," Gramley said.

The Chicago Purchasing Managers survey was also constructive to the market. The index fell to 50.1 to 53.9. While a reading over 50.0 indicates an expanding manufacturing sector, the index has moved steadily lower in recent months.

The market did an about-face at midday as concerns over the deficit reduction package again moved to the forefront, due to reports that the White House expected the final version of President Clinton's deficit reduction plan to weigh in around $490 billion instead of the expected $500 billion. While the new figure was generally acceptable to the market, traders said Clinton's willingness to compromise on the plan made the market jittery.

Late in Friday's session, prices edged lower as participants took profits. Traders said the ongoing budget debate has left investors nervous about holding onto positions over the weekend.

The September bond futures contract ended down 3/32 at 115.19. In the cash markets, the 4 1/8% two-year note was quoted late yesterday down 2/32 at 100.07-100.08 to yield 4.11%; the 5 1/4% five-year note ended down 4/32 at 100.13-100.15 to yield 5.14%; the 6 1/4% 10-year note was down 4/32 at 105.05-103.07 to yield 5.80%; and the 7 1/8% 30-year bond was up 2/32 at 107.08-107.10 to yield 6.56%.

The three-month Treasury bill was up one basis point at 3.08%; the six-month bill was up two basis points at 3.20%; and the year bill was up two basis points at 3.44%.Treasury Market Yields Prev. Prev. Friday Week Month3-Month Bill 3.08 3.14 2.996-Month Bill 3.27 3.31 3.131-Year Bill 3.51 3.61 3.312-Year Note 4.11 4.18 3.913-Year Note 4.40 4.51 4.225-Year Note 5.14 5.24 4.967-Year Note 5.44 5.58 5.3710-Year Note 5.80 5.92 5.7430-Year Bond 6.56 6.69 6.66

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