TREASURIES-Bonds fall as Q3 GDP raises recovery hopes

* U.S. Q3 GDP grew 3.5 pct, faster than expected

* U.S. Treasury 7-year note auction disappoints

* Jobless claims hint at some U.S. labor stabilization (Adds economist's quote, updates prices)

By Chris Reese

NEW YORK, Oct 29 (Reuters) - U.S. Treasury debt prices fell on Thursday as data showed the U.S. economy grew at a faster-than-expected pace in the third quarter, raising hopes of an emergence from the worst recession in 70 years.

A rebound in U.S. stocks also gnawed at the bid for low-risk government debt, while some disappointment over the level of demand in an auction of $31 billion of seven-year notes also took a bite out Treasury debt values.

"The auction was a little disappointing ... with the (gross domestic product) numbers and the rally in stocks, it looks like the market is suffering from some indigestion," said Kim Rupert, managing director of global fixed income analysis at Action Economics LLC in San Francisco.

Benchmark 10-year Treasury notes US10YT=RR traded 21/32 lower in price to yield 3.50 percent, up from 3.42 percent late on Wednesday, while the 30-year bond US30YT=RR traded 1-13/32 lower to yield 4.34 percent from 4.26 percent.

The 3.5 percent third-quarter rise in U.S. gross domestic product beat a 3.3 percent increase forecast by economists. The government's first GDP reading for the quarter surprised some traders who had lowered their outlook in the wake of disappointing data in recent days. For more, see [ID:nLT403984]

The data had some speculating that the Federal Reserve could tweak its policy statement at a meeting next week to indicate they are at least considering winding down some of the massive amounts of fiscal stimulus intended to prop up financial institutions and the economy.

"Today's report is a strong one and it is likely to spark the start of the Fed's exit strategy," said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York, adding "first they will begin to withdraw the liquidity and then in the first half of 2010 we expect them to raise rates from emergency levels."

Treasuries briefly extended losses on Thursday afternoon in some disappointment that there was not a larger appetite for seven-year notes in the auction.

The sale was part of a record-large weekly offering of $123 billion of Treasury notes, and investors continue to fret over the possibility of waning demand for the massive doses of U.S. government debt.

Seven-year notes US7YT=RR traded 14/32 lower in price to yield 3.07 percent, up from 3.00 percent late on Wednesday.

Bonds were also undermined early in the day by the latest figures showing the number of workers filing for unemployment benefits has been falling, although they remain at elevated levels.

Also of note on Thursday, the Fed made its last purchase under its $300 billion Treasury program. The program was launched seven months ago in a move to hold down long-term interest rates and to stimulate the economy.

Two-year notes traded 3/32 lower in price to yield 0.99 percent, up from 0.95 percent late on Wednesday.

For a graphic of recent Treasury debt auctions click here (Additional reporting by Richard Leong; Editing by Diane Craft)