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NEW YORK, July 27 (Reuters) - U.S. Treasuries rose on Friday, driving benchmark yields to fresh two-month lows, as stocks stayed under pressure with investors worried over tighter access to credit.
Data showing the U.S. economy grew at a surprisingly strong rate in the second quarter of 2007 only briefly calmed fears of a slump following this week's turmoil in global financial markets. See [ID:nN27292437] for details.
However, analysts said the government bond rally was starting to show signs of fatigue, preventing Treasuries from tapping a strong flight-to-quality bid from the distressed equity market.
"It's all equities here. The volatility in the stock market has pushed Treasuries higher and yields lower, but it hasn't been what you might expect," said Carley Garner, an analyst at Alaron Trading in Chicago.
The benchmark 10-year Treasury note US10YT=RR earlier traded as high as 13/32 for a yield of 4.75 percent, but retreated to be 7/32 up to yield 4.78 percent in New York afternoon trade.
This was as the stock market cut earlier losses. Yields, which move inversely to prices, traded around 4.81 percent late on Thursday.
"Technically the market is getting a little tired here. If the stock market stabilizes, bonds should get a correction," said Garner.
"On the 10-year note, 4.75 percent is huge. I don't think we are going to break it for any long period of time. We might touch that level, run some stops through there, but from there we should get a correction."
Based on the fall in yields, 10-year notes were closing in on their best weekly rally since September 2006, surpassing even the week that included the flight-to-quality rally of February 27 this year.
Credit crunch fears have fanned speculation that the Federal Reserve could cut interest rates earlier than expected, with Fed funds futures showing a roughly 80 percent chance of an ease by year-end.
"They (Fed) may be forced into the game sooner than they would like if the sentiment continues to fall like it has in the last two weeks," said Kevin Giddis, head of fixed income trading at Morgan Keegan in Memphis, Tennessee.
"The housing situation is not likely to correct itself in the near future and the more we learn, the uglier it gets."
Two-year notes US2YT=RR, the most sensitive to changing views on Fed interest rate moves, gained 3/32, yielding 4.55 percent. Earlier two-year yields fell to 4.48 percent, their lowest since March.
At current levels, two-year yields essentially factor in the equivalent of three quarter-point interest rate cuts from the current federal funds rate of 5.25 percent. Two-year notes were close to having their best week since late 2005.
The 30-year long bond US30YT=RR rose 17/32, pushing the yield down to 4.94 percent, versus 4.97 percent late on Thursday.
The market showed little reaction to a slightly softer-than-expected reading on consumer sentiment from the Reuters/University of Michigan Surveys of Consumers.
(Additional reporting by Burton Frierson)