The Treasury market reacted predictably to the

Fed's action on interest rates: Long-maturity issues rallied, since the Fed's vigilance against inflation should keep inflation low, preserving the value of those instruments. But short-maturity yields, which correspond more closely to the short-term

fed funds rate, stayed high, anticipating additional rate hikes later this year.

A slightly better-than-expected performance by the April

Consumer Price Index also supported long-term Treasury prices Tuesday.

"No one's saying that we'll never have inflation again, but the Fed's dealing with it," said Matthew Kuhns, a bond portfolio manager for

Transamerica

. And that's positive for long-maturity Treasuries, he added.

The benchmark 10-year Treasury note ended up 7/32 at 100 17/32, trimming its yield 3 basis points to 6.422%. But the two-year note lost 1/32 to 99 3/32, lifting its yield 2.6 basis points 6.876%.

The 30-year Treasury bond rallied 19/32 to 101 29/32, lowering its yield 4.6 basis points to 6.110%. At the

Chicago Board of Trade

, the June

Treasury futures contract gained 15/32 to 94 17/32.

In a move that virtually every Wall Street forecaster was expecting, the

Federal Open Market Committee hiked the fed funds rate to 6.5% -- the highest since 1991 -- from 6%. It was the sixth rate hike since June, but it was the first rate action larger than 25 basis points since February 1995.

Explaining the move in a

statement, the FOMC said: "Increases in demand have remained in excess of even the rapid pace of productivity-driven gains in potential supply, exerting continued pressure on resources." Left unchecked, it continued, this disparity "could foster inflationary imbalances that would undermine the economy's outstanding performance."

While almost everyone on Wall Street was prepared for the rate action, it appears that some were unprepared for the strong statement, which indicates the Fed is likely to deliver additional rate hikes in the months ahead. At the Chicago Board of Trade, the prices of

fed funds futures fell sharply, indicating a building consensus that the rate is headed up. For example, the contract that, on Monday, discounted a fed funds rate of 6.925% by September, on Tuesday discounted a rate of 6.965%.

"There's a debate on what the Fed has to do down the line," said Richard Bodkin, government bond trader at

Banc One Capital Markets

. "Either there's substantially more tightening to go, or the tightening cycle is nearing completion."

Needless to say, anyone hoping for an indication that Tuesday's action by the FOMC might be its last was sorely disappointed.

Kuhns of Transamerica expects the next rate hike -- either 25 or 50 basis points -- at the FOMC's next meeting June 27-28. With oil prices on the rise again, future inflation reports won't look as nice as Tuesday's CPI, he reasons. "The concern is that they fall behind the curve."

But at the same time, when you consider that Tuesday's action was the Fed's most aggressive in years, the market's performance Tuesday was downright impressive, some say. "If anything was notable it was the lack of volatility, given that this was a pretty aggressive move for a Fed that's been known as unaggressive," said David Connors, government bond trader at

Credit Suisse First Boston

.

Economic Indicators

The Consumer Price Index was unchanged in April following nine months of increases. Economists polled by

Reuters

had forecast a 0.1% gain.

A 1.9% decline in energy prices held consumer prices down. Excluding energy and food prices, the CPI rose 0.2%, in line with the average forecast.

The year-on-year growth rate of consumer prices dropped to 3.0% from 3.7% in March. The rate for core consumer prices dropped to 2.2% from 2.4%.

In other economic news,

real earnings rose 0.7% in April, as unchanged consumer prices did not affect the 0.7% gain in seasonally adjusted average weekly earnings reported by the

employment report.

Meanwhile,

housing starts rose a little more than expected in April. As mortgage rates drifted lower in April, the pace of housing starts quickened to 1.663 million from 1.618 million. But building-permit issuance, a leading indicator of housing starts, slowed to 1.574 million from 1.597 million. Starts peaked at 1.822 million in February.

Finally, the weekly retail sales reports benefited from Mothers Day. The

BTM Weekly U.S. Retail Chain Store Sales Index rose 0.9%, lifting the year-on-year pace to 2.0% from 1.2%, and the

Redbook Retail Average found May sales running 0.3% ahead of April.

Currency and Commodities

The dollar rose against the yen and the euro. It lately was worth 109.57 yen, up from 109.29. The euro was worth $0.9001, down from $0.9115. For more on currencies, please take a look at

TSC's

Currencies column.

Crude oil for June delivery at the

New York Mercantile Exchange

retreated to $29.72 a barrel from $29.92.

The

Bridge Commodity Research Bureau Index

rose to 221.98 from 219.98.

Gold for June delivery at the

Comex

fell to $276.20 an ounce from $276.40.