Long-term Treasury prices managed to move higher last week despite $36 billion of refunding supply dumped into the market by the government.

Late Friday, the 30-year bond was yielding 7.32%, down from the 7.39% yield a week earlier.

The market behaved well through the three refunding auctions, then sold off abruptly Thursday afternoon after James Baker, newly appointed White House chief or staff, talked about making lower tax rates a key part of President Bush's re-election campaign.

But traders said the sell-off was mostly a response to the enormous quantity of supply in dealers' hands by that time.

On Friday, prices retraced some of those losses as dealers managed to distribute some of the new securities, aided by the market's second thoughts about Mr. Baker's remarks and the mostly friendly economic news.

In fact, through all of last week's ups and downs, the indicators continued to depict an economic situation favorable for the bond market. Once the logjam of supply has been dealt with, traders said, the economic fundamentals will result in still higher Treasury prices and lower yields.

The market got a string of good inflation numbers last week, including 0.1% gains in July consumer and producer prices. July retail sales rose only modestly and a bigger than expected increase in July industrial output was blamed on one-time increases in the utility and mining sectors.

The market also got its first reports on August activity - the Johnson Redbook report on department store sales for the first week of the month, car sales figures for the first 10 days, and the University of Michigan's preliminary report on this month's consumer sentiment - and all of them showed weakness.

"Fundamentally, things are still pretty positive for the longer end," said Daniel Seto, an economist at Nikko Securities. "We've had some of the best inflation news seen in years; and with the economy still moving sideways, it's hard to imagine that inflationary pressures will be a problem for the next year or year and a half, at least."

Mr. Seto said he thought Treasury yields could move lower over the next six months. "The only major risk I see is if Congress comes back and tries to push through a stimulative package. That may jeopardize the market's rally."

Joel Naroff, chief economist at Fidelity Bancorp., said he thought the rally would continue as long as the housing sector did not show outsized gains.

But even in the wake of the Federal Reserve's rate cut in early July, Mr. Naroff is forecasting only "mediocre" improvement in the housing numbers. For example, he expects an increase of 5% to 7% in tomorrow's July housing starts.

As long as housing improves slowly, the 30-year bond yield can go as low as 7%, he said.

"The question is, do things go so badly that we break below 7%," Mr. Naroff said. "I think that would require indications that we're heading for a triple dip."

Aside from tomorrow's housing starts report, the economic numbers this week are somewhat boring, and traders said the market will focus instead on the Republican National Convention and the Federal Open Market Committee meeting.

The Fed is the easier read of the two. Analysts don't expect any change in policy from tomorrow's meeting, but say the Fed is likely to cut the funds rate another 1/4 point eventually if the recovery remains anemic.

The impact of the Republican convention is not as clear.

A government bond trader argued that it was more likely to help than hurt the market.

"I think a lot of people have in their mind that [Democratic presidential nominee Bill] Clinton has a pretty impressive lead and could win," the trader said. "If the Republicans put together a nice little pep rally, it'll be good for the market."

Kevin Flanagan, an economist at Dean Witter Reynolds Inc., argued that the convention would have little impact.

"Right now, the market doesn't know who will be President," he said.

"I think the only way the market will react to [the convention] is if they bring up this tax thing," Mr. Flanagan said. "But I think we're realizing that Baker's talk may have been slightly misrepresented.

White House spokesman Marlin Fitzwater said Friday that Mr. Baker did not have any specific changes in mind, and that President Bush is "committed to keeping the deficit down and cutting spending."

Friday's Activity

Treasury prices rose 1/8 to 5/8 point Friday as dealers managed to distribute some of the securities that were auctioned over the course of last week.

Late in the afternoon, the new 30-year bond was up 5/8 point to yield 7.32% in when-issued trading.

Prices began to improve overnight in Tokyo as investors spotted some bargains at the low levels reached after Thursday's sell-off.

The market resumed its rally in New York on the news that the University of Michigan had told subscribers to its economic report that consumer sentiment eroded more in early August.

Most of the buying interest was at the short end, traders said, with reports that the Fed had bought five-year notes under the table and that a retail investor had purchased a lot of two-year notes.

"The market's putting in a pretty good performance," a government note trader said. "Now that dealers have been taken out of some of the paper, the market's a little more comfortable."

The market also benefited because traders were questioning whether the market had overreacted Thursday to comments about lower taxes by Mr. Baker.

Friday's indicators were mixed, but on the whole favorable for the bond market.

Most encouraging was the University of Michigan's preliminary report on August consumer sentiment. The university's index fell to 75.3, from the 76.6 July reading.

Economists said that even though the decline was not that big. the index remains at very low levels, suggesting there will be little improvement in consumer spending during the month.

The 0.6% jump in June business inventories was also friendly because it suggested demand was so weak that businesses were accumulating inventories involuntarily.

And economists said even though the industrial production report showed a 0.4% increase for July, when the consensus forecast only called for a 0.1% gain, the improvement was all in utilities and mining, while the manufacturing output was unchanged.

The September bond futures contract closed 13/32 higher at 106.

In when-issued trading, the 30-year 7 1/4% bond was 5/8 higher, at 99 1/32-99 5/32, to yield 7.32%.

The when-issued 6 3/8% 10-year note rose 13/32, to 98 30/32-99 2/32, to yield 6.50%, slightly above the 6.49% average yield at Wednesday's auction.

Treasury Market Yields

Prev. Prev.

Friday Week Month

3-Month Bill 3.11 3.19 3.21

6-Month Bill 3.23 3.26 3.29

1-Year Bill 3.36 3.39 3.47

2-Year Note 4.08 4.13 4.22

3-Year Note 4.63 4.57 4.72

5-Year Note 5.49 5.54 5.79

7-Year Note 6.02 6.04 6.37

10-Year Note 6.50 6.54 6.89

15-Year Bond 6.92 6.92 7.24

30-Year Bond 7.32 7.39 7.67

Source: Cantor, Fitzgerald/Telerate

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