The interior ministry said in a statement that the gunmen were "holed up in houses and certain areas near the marketplace in Loder".
Earlier, a local security source had said the armed men involved in the firefight may have been Al-Qaeda members, but another local official said they could be linked to a southern separatist movement.
However, a member of the separatist Southern Movement coalition of secessionist groups denied its supporters had staged the attack.
"We reject such acts - the Southern Movement uses only peaceful means to secure independence for the people of the south," Aydarus Haqis told the AFP news agency.
At the same time he condemned "the actions of the army, especially the indiscriminate shelling by tanks" of a residential area of Loder.
Friday's fighting came after a two-hour clash in the same city the previous day, in which armed men killed two soldiers and wounded two others.
Thursday's firefight erupted after two soldiers were attacked in the marketplace and their weapons were seized, leading to the intervention of the army.
Southern Yemen, which was independent from 1967 to 1990 and briefly seceded again in 1994, sees frequent protests and separatist unrest.
Locals complain of discrimination by the government in the north over the allocation of resources.
However, it also feared that the region is becoming a base for Al-Qaeda in the Arabian Peninsula.