Treasuries rallied substantially, with the shortest-maturity issues leading the way, thanks to a marginally better-than-expected May Consumer Price Index, a coupon pass and a renewed focus on the federal budget and its implications for the supply of Treasury securities.

The benchmark 10-year Treasury note gained 16/32 to 103 9/32, dropping its yield 6.8 basis points to 6.045%, the lowest since late April. Meanwhile, the two-year note gained 5/32 to 100 12/32, lowering its yield 9 basis points to 6.412%, also a six-week low. And the 30-year bond rallied 17/32 to 104 24/32, trimming its yield 3.6 basis points to 5.909%.

At the

Chicago Board of Trade

, the September

Treasury futures contract added 18/32 to 97 9/32.

The CPI brought many more people into the majority camp that believes the

Fed will refrain from hiking the

fed funds rate again at its next meeting on June 27-28. The likelihood of such a move was downgraded to 26% from 32% today by traders of

fed funds futures at the

Chicago Board of Trade

. The Fed's latest

Beige Book, released this afternoon, conformed with that view, describing the economy as having begun to cool.

The coupon pass, executed at about 10:30 a.m. EDT, took $552 million of bonds due between 2020 and 2023 out of circulation, on a day when $30.4 billion changed hands by 3 p.m. EDT, according to tracker

GovPX

.

The coupon pass was the first of several events that reversed an early selloff at the long end of the Treasury market, as shorter-maturity issues rallied after the release of the CPI.

The early selling was due in part,

IFR

managing analyst Ken Logan said, to foreign investors concerned that a slowing U.S. economy will weaken the value of the dollar. Those investors have been selling Treasuries recently to lighten up on dollar-denominated assets, and that continued today, Logan said.

There was also a continuation of

yesterday's trade, in which people sold long-maturity Treasuries and bought short-maturity ones, unwinding a position that was popular over the previous several weeks, Logan said.

The selling of long Treasuries stopped with the coupon pass. But over the course of the day, at least two other developments encouraged buying of Treasuries.

The first was comments by Argentine economy minister Luis Machinea, who told reporters in Washington after a meeting with Fed Chairman

Alan Greenspan that he had gotten the impression that U.S. rates are unlikely to rise much more.

The second was comments by Senate Majority Leader

Trent Lott

, who said he expects the

Congressional Budget Office

to forecast larger federal budget surpluses in its next report, due out sometime after July 4. Larger surpluses mean more funds that can be used to pay down federal debt by buying Treasury securities back from investors in order to take them permanently out of circulation, a program that has driven up the price of long-maturity Treasuries in particular.

With the release of the May CPI, the most influential pieces of economic data prior to the next Fed meeting are out, and some market-watchers say that Treasury prices are likely to trade in a narrow range till the end of the month, if not beyond.

"The consensus is that we're in a range for the forseeable future," said Avram Altaras, Treasury market strategist at

Bear Stearns

. "Most people can't see what would cause the market to break to the upside or the downside."

Economic Indicators

The CPI advanced 0.1% in May. Economists polled by

Reuters

had forecast a 0.2% gain, on average.

Excluding food and energy the CPI rose 0.2%, in line with the average forecast. Food prices rose 0.5%, while energy prices fell 1.9%. The energy price decline was surprising,

PaineWebber

chief economist Maury Harris pointed out in a research note, standing "in sharp contrast to the U.S. Energy Department's reported 4.8% monthly rise in conventional regular unleaded gasoline prices to $1.472 in May." That and subsequent increases "should be reflected in the June CPI data," Harris said.

The year-on-year growth rate of the CPI edged up to 3.1% from 3.0%, while the rate for the core CPI rose to 2.4% from 2.2%.

In other economic news,

real earnings

fell 0.3% in May, as the 0.1% rise in the CPI collided with the 0.2% drop in nominal weekly earnings reported by the May

employment report

.

Business inventories rose 0.4% in April, a tenth more than expected, but the pace of business sales growth, at 6.4%, remained substantially faster than the pace of inventories growth, at 5.5%.

Finally, the weekly

Mortgage Application Survey

detected an increase in refinancing activity and a decrease in new mortgage activity. The Refinancing Index rose to 329.4 from a revised 318.1, while the Purchase Index fell to 309.5 from a revised 335.0.

Currency and Commodities

The dollar fell against the yen and rose against the euro. It lately was worth 106.64 yen, down from 106.92. The euro was worth $0.9581, down from $0.9590. For more on currencies, please take a look at

TSC's

Currencies column.

Crude oil for July delivery at the

New York Mercantile Exchange

rose to $32.85 a barrel, a three-month high, from $32.56.

The

Bridge Commodity Research Bureau Index

fell to 224.71 from 224.88.

Gold for August delivery at the

Comex

rose to $294.20 an ounce from $288.10.