Treasury prices rallied yesterday on the news of a surprisingly large decline in April housing starts, and the short end outpaced the rest of the market because the weak housing report nourished traders' hopes for a near-term easing by the Federal Reserve.

Late yesterday, short-term notes were up 1/4 to 1/2 point, and the 30-year bond was 5/8 higher to yield 7.76%. This was the lowest closing yield on the long bond since early February.

Treasury prices shot higher early in the session yesterday when the Commerce Department reported that April housing starts had fallen 17%. The consensus forecast was for a 6.6% decrease.

The market held onto those early gains throughout the session, then inched a little higher late in the day.

Traders said flows were very thin after the initial run-up, as participants retired to the sidelines to see whether the Fed will alter monetary policy today.

The Federal Open Market Committee, which sets monetary policy, met yesterday, and the plunge in April housing starts increased expectations that the committee would vote to cut its funds target immediately to 3 1/2% from the current 3 3/4%.

Today's "Fed time is very important," said Frederick Leiner, a market strategist at Continental Illinois National Bank & Trust, referring to the period between 11:35 and 11:45 a.m., edt, when the Fed typically intervenes to add or subtract reserves from the monetary system.

"If they've decided at the meeting to reduce the funds rate immediately, they should indicate that to the market" today, Mr. Leiner said. "If they're waiting for more data, then it could well be early June" before the Fed signals it is easing.

William Sullivan, director of money market research at Dean Witter Reynolds Inc., said the decline in housing starts gives the Fed more leeway to ease and fits in with other signs of weakness like the sluggishness in money supply growth and lackluster auto sales.

"What we have is a narrowly based recovery that has to be characterized as fragile," Mr. Sullivan said.

He added that the recent gains in

Treasury prices might also encourage

Treasury Market Yields

Prev. Prev.

Tuesday Week Month

3-Month Bill 3.59 3.68 3.76

6-Month Bill 3.71 3.84 3.97

1-Year Bill 3.96 4.12 4.28

2-Year Note 4.93 5.15 5.35

3-Year Note 5.55 5.76 5.90

4-Year Note 6.42 6.62 6.84

5-Year Note 6.44 6.64 6.86

7-Year Note 6.83 7.00 7.21

10-Year Note 7.18 7.34 7.55

15-Year Bond 7.48 7.60 7.81

30-Year Bond 7.76 7.85 8.03

Source: Cantor, Fitzgerald/Telerate

Fed policymakers to loosen credit. "If bond investors feared the inflationary consequences of another round of easing, you wouldn't have had this bond market rally."

Other analysts agred that the weaknes in housing starts would be a matter of concern for policymakers, but said it was far from certain the Fed would choose to act immediately.

Sally Kleinman, a financial markets analyst at Chemical Securities, said she still expects Fed policymakers to wait to see the May employment report early next month before making any move.

And Carol Stone, a senior economist at Nomura Securities International, said it was possible to make a case against another Fed easing, given the weakness in housing starts.

"Sustained strength in housing and other business areas really needs lower long-term rates and the Fed might accomplish lower long-term rates by leaving the funds rate where it is, rather than lowering it," Ms. Stone said.

The market had such a firm tone yesterday that traders and analysts said even if the Fed does not signal an ease today, they expected prices to decline only modestly going into this afternoon's auction of $14.75 billion of two-year notes.

Although the market "could have to back and fill to complete the auction successfully, under no circumstances should we look for a sharp break in prices," Mr. Sullivan said. "Just because the Fed doesn't ease [today] doesn't mean they won't ease at all."

Mr. Leiner said the long bond was facing such formidable resistance at 7 3/4% that he would be wary of owning long bonds at current levels.

"I don't like the risk/reward [ratio] of being long here," he said. "At the least, the market is going to have to do some more work here, and the worst case is we fall."

But other observers said technical indicators suggest the market will break through that resistance at 7 3/4%.

Analysts predicted the market will ignore this morning's report on March merchandise trade. The consensus forecast is for a $4.6 billion gap, up from the $3.4 billion deficit in February.

April Housing Starts

Analysts said the 17% plunge in April housing starts was not as bad as it looked on the surface.

A big chunk of the April decline occurred in multifamily starts, which fell 41.3% after rising 74.2% in March, but economists dismissed those swoops as statistical noise.

They were worried, though, about the 10.6% fall in April single-family starts, to a 963,000 annual rate, from 1.077 million units in March.

"This is a shocker," said Stephen Roach, a senior economist at Morgan Stanley.

Mr. Roach said the recent rise in mortgage rates was probably to blame for the decline in single-family starts and he noted that the rally in the bond market meant mortgage rates were now at more favorable levels than they were in April.

Still, he said, the weakness in April shows that "the housing recovery, which had been narrowly based in the single-family area, is a pretty fragile one."

The April plunge erased the gains in housing posted during the first quarter and left single-family starts close to the 972,000 level posted last December.

"All of the gains in the warm-weather, low-interest-rate environment in the winter are undone by this," said Ms. Stone of Nomura. "What it may be saying is that the strength early in the year just borrowed from the spring rather than presaging a firm uptrend in housing activity."

In another sign of weakness, permits for single family homes fell 3.3%, to 1.058 million units. Permits are used as a measure of future housing activity.

The June bond futures contract closed 19/32 higher at 101 18/32.

In the cash market, the 30-year 8% bond was 21/32 higher, at 102 20/32-102 24/32, to yield 7.76%.

The 7 1/2% of 10-year note rose 17/32, to 102 2/32-102 6/32, to yield 7.18%.

The three-year 5 7/8% note was up 5/16, at 100 26/32-100 28/32, to yield 5.55%.

In when-issued trading, the two-year note to be sold today was bid at 5.04%, down from 5.17% late Monday, and the five-year note to be auctioned tomorrow was yielding 6.49%, down from 6.62% Monday.

Rates on Treasury bills were lower, with the three-month bill down eight basis points at 3.53%, the six-month bill off nine basis points at 3.62%, and the year bill eight basis points lower at 3.82%.

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