TREASURIES-Bonds fall before payrolls; TIPS outperform

Thu Dec 2, 2010 5:07pm EST

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* Benchmark yields hover at 3 pct in advance of jobs data

* TIPS breakevens widest since May on improved outlook

* Trading choppy on wavering perception on Europe

* Treasury to sell $66 bln in coupon supply next week (Updates market action, adds new quotes, changes byline)

By Richard Leong

NEW YORK, Dec 2 (Reuters) - U.S. Treasury debt prices fell on Thursday with benchmark yields hovering at 3 percent for a second day as traders braced for another solid jobs report on Friday.

An improving U.S. economic outlook siphoned money into stocks and risky assets from bonds for a second straight day. Some traders also hedged against the case that payrolls could have increased in November by more than the median forecast of 140,000 among economists recently polled by Reuters.

"The market is recalibrating itself for a higher level of growth," said Mark Pawlak, market strategist at Keefe, Bruyette & Woods in New York.

Anticipation of stronger economic growth, together with higher oil prices, resulted in Treasury Inflation-Protected Securities' better performance versus their nominal or regular counterparts. The yield gap between 10-year TIPS and 10-year nominals -- a gauge of long-term inflation expectations -- grew to 2.21 percent, the widest since mid-May.

This rethinking of the economy was mitigated by wavering confidence in Europe's response to its fiscal predicament. It helped avert a sell-off like one on Wednesday when the 10-year yield posted its second largest one-day spike so far in 2010.

Bond prices briefly turned positive after comments from European Central Bank President Jean-Claude Trichet disappointed those traders who bet the ECB would buy government debt, like the U.S. Federal Reserve, in a bid to stabilize the region. The view of a reserved ECB was offset by talk of it buying Portuguese and Irish debt in the open market. See [ID:nLDE6B10I4]

"People want them (ECB policy-makers) to act like the Fed, but they are not. It is disappointing in a sense, but it is not surprising," said Keefe Bruyette's Pawlak.

Benchmark 10-year note prices US10YT=RR fell 9/32 in late trading for a yield of 3.00 percent after touching 3.03 percent, its highest since late July. Analysts see the 10-year yield will probe technical support at 3.05 percent, then 3.10 percent if it rises further.

Separately, the U.S. Treasury Department said it will sell a combined $66 billion in three-year, 10-year and 30-year debt next week. For more, see [ID:nWAL2NE6U2]

QE2, INFLATION

The fate of the Fed's $600 billion bond purchase program, dubbed QE2, remains a point of debate among investors and even policy-makers. Critics of QE2 said more bond purchases could lead to a surge in inflation and damage the dollar.

A pair of Fed officials said on Thursday the second bout of quantitative easing that began in November is subject to regular review and the central bank may have not to buy all $600 billion. [ID:nN02241796]

St. Louis Fed President James Bullard, who is a voting member of the Federal Open Market Committee this year, said he had not supported setting the $600 billion figure in advance.

"That spooked some people in the market," said Suvrat Prakash, interest rate strategist at BNP Paribas in New York. "It raises concerns it won't go through with the program."

Traders had bet on Fed's commitment to buy this total amount of Treasuries through mid-2011. On Thursday, it purchased $8.3 billion in government debt due in Feb. 2018 to Aug. 2010. For more, see [ID:nN20EDTABL]

Some investors said QE2 is helping the economy even though bond yields have been rising since it started in mid-November.

"This round of quantitative easing will help support growth over the next couple of quarters," said Ray Humphrey, senior portfolio manager at Hartford Investment Management Co. in Hartford, Connecticut.

Humphrey, who helps manage the Hartford Inflation Plus Fund (HIPAX.O), recommends investors to consider moving money into TIPS. "There is inflation coming," he said. (Additional reporting Karen Brettell; Editing by Andrew Hay)

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