July 31, 2014 / 3:40 PM / in 3 years

TREASURIES-Prices stable, erase earlier losses, on month-end demand

(Adds quote, Chicago manufacturing data, updates prices)
    * Yield curve steepens from five-year lows
    * Month-end demand erases earlier price losses
    * Inflation risk seen as labor costs rise

    By Karen Brettell
    NEW YORK, July 31 (Reuters) - U.S. Treasuries were steady on
Thursday, erasing earlier price losses, as investors sought out
lower risk debt for month-end rebalancing.
    U.S. government debt has weakened since gross domestic
product data on Wednesday showed a strong rebound in the second
quarter from a weak start to the year.
    That extended into Thursday morning as data showed U.S.
labor costs recorded their largest increase in more than 5-1/2
years in the second quarter, a sign that a long-awaited
acceleration in wage growth was imminent. 
    The debt stabilized, however, as some investors shifted out
of stocks and into bonds to adjust month-end balance sheets.
    "There is some month-end buying, both here and in Europe,"
said Dan Mulholland, managing director in Treasuries trading at
BNY Mellon in New York.
    Treasuries also pared losses after a report showed the pace
of business activity in the U.S. Midwest in July sank to its
slowest level since June 2013. 
    Benchmark 10-year notes were little changed to
yield 2.56 percent, after earlier rising as high as 2.61
percent, the highest since July 8.
    Rising labor costs earlier on Thursday led some investors to
see a greater likelihood the Federal Reserve will increase
interest rates next year, while others fear that higher
inflation is likely if the U.S. central bank is too slow to act.
    "In general, you have decent data and if the Fed's behind
the curve, you will wind up with inflation running a little bit
higher than people thought," said Ira Jersey, an interest rate
strategist at Credit Suisse in New York.
    The Fed acknowledged firmer prices and improving data on
Wednesday but also expressed concern about remaining slack in
the labor market. 
    The yield curve steepened as investors adjusted to the
prospect of higher inflation. The yield gap between five-year
notes and 30-year bonds steepened to 156 basis points, up from a
five-year low of 149 basis points on Wednesday.
    A Morgan Stanley index meant to gauge the timing of the
first interest rate hike (M1KE) on Wednesday suggested that an
increase may occur within 12 months, the first time since 2011
that the index has indicated one will occur within a year, an
analyst at the bank said in a report on Wednesday.
    Based on this indicator, two-year note yields should pay
0.68 percent, the bank added. That is 12 basis points higher
than the notes' current yield of 0.56 percent.
    The next major focus will be Friday's jobs report for July.
Employers are expected to have added 233,000 jobs in the month,
according to the median estimate of 100 economists polled by

 (Editing by Nick Zieminski and Tom Brown)

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