Bonds gain as PCE soothes some inflation worries

NEW YORK (Reuters) - U.S. Treasury debt prices rose on Friday after a key inflation reading that was in line with expectations provided investors some relief that price pressures may not be careening out of control.

Bond prices were also supported by month-end position squaring and some short covering after three previous sessions of sharp losses. A relatively lackluster reading on consumer confidence also helped bolster government debt.

Government data showed the core personal consumption expenditures price (PCE) index, which does not include food and energy prices and is one of the Federal Reserve's favored measures of inflation, rose by 0.1 percent in April, which was as expected.

"The inflation data is pretty mild ... Treasury prices are up a little bit -- the (PCE) numbers were not quite as bad as they could have been," said Scott Brown, chief economist with Raymond James & Associates in St. Petersburg, Florida.

Benchmark 10-year Treasury notes were trading 8/32 higher in price for a yield of 4.05 percent from 4.08 percent late on Thursday, while 2-year Treasury notes were trading 3/32 higher in price for a yield of 2.63 percent from 2.69 percent.

Bond prices have plunged in the previous three sessions and yields have risen, driven primarily by expectations that high food and energy costs will permeate the entire economy and boost inflation.

Traders moved on Friday to take back some of those recent losses.

"You do have some month-end buying that is offering a little bit of support, and the market was perhaps oversold given the extent of the sell-off through yesterday afternoon, so there may be some short covering ahead of the weekend," said John Canavan, analyst at Stone & McCarthy Research Associates in Princeton, New Jersey.

U.S. consumer confidence for May, while up slightly from an initial estimate, still fell to a 28-year low, according to the Reuters/University of Michigan Surveys of Consumers.

"Consumer sentiment is still negative," said William O'Donnell, head of U.S. interest rate strategy for UBS Securities in Stamford, Connecticut, adding bonds overall were reacting to these "bunch of different things" including month-end position squaring and the PCE data.

Little market impact was seen from data showing business activity in the U.S. Midwest contracted for the fourth straight month in May, although the rate of the downturn moderated.

Five-year Treasury notes were trading 7/32 higher in price for a yield of 3.38 percent from a high yield of 3.52 percent in an auction of the notes on Thursday.

The 30-year bond was 18/32 higher for a yield of 4.72 percent from 4.75 percent.

(Additional reporting by John Parry; Editing by Chizu Nomiyama)