October 1, 2010 / 8:45 PM / 8 years ago

TREASURIES-Fed officials' support of QE2 curbs bond losses

* Consumer, construction spending better-than-expected

* ISM data show slower U.S. manufacturing growth

* NY Fed Dudley says current low inflation “unacceptable”

* Chicago Fed’s Evans saying more easing “desirable” (Updates market action, changes quotes, byline)

By Richard Leong

NEW YORK, Oct 1 (Reuters) - U.S. Treasuries dipped on Friday, as data that was mildly encouraging for the economy offset hints from Federal Reserve officials that they would be supportive of the central bank buying more bonds to bolster the sluggish economy.

Bonds also succumbed to investors shifting money into stocks after Wall Street posted its best quarter in a year. For more, see [.N]

Adding to the downward pressure on bonds on the first day of the fourth quarter was dealers locking in rates on bonds they are underwriting next week, analysts said.

“The economic data have not been great, but they are not falling off a cliff either,” said Brian Rehling, senior fixed income strategist at Wells Fargo Advisors at St. Louis, Missouri.

Friday’s batch of reports showed U.S. manufacturing, which has been the lone bright spot during this uneven recovery, grew at a slower pace in September, while consumer and construction spending rose more than forecast. [ID:nN01186494]

Bond selling after these reports was countered by bargain-hunting and calls from two top Fed officials for more policy easing.

New York Fed President William Dudley said on Friday current conditions of high unemployment and low inflation as “unacceptable,” while Chicago Fed chief Charles Evans said more easing was “desirable.” For more, see [ID:nN01261676]

Their seeming support for a second round of quantitative easing, dubbed “QE2” by analysts, contrasted with remarks from other Fed policymakers earlier this week, which reduced expectations over the need for further policy accommodation.

Bonds’ modest pullback on Friday, led by longer-dated maturities, underscored just how much traders piled on bets that the Fed will conduct QE2 before year-end, analysts said.

“The comments from Dudley should have been bullish, but the market was already so bullish,” said Michael Kastner, partner at Halyard Asset Management in White Plains, New York.

The benchmark 10-year Treasury note US10YT=RR ended down 3/32 in price, paring an earlier 18/32 drop. Its yield, which moves inversely with its price, was 2.52 percent after traded as high as 2.58 percent.

The 10-year yield has encountered chart resistance in the 2.45-2.46 percent area, and found support at 2.60 percent.

Technical indicators suggest continued intraday volatility for bond yields within their recent trading range.

The 30-year bond US30YT=RR was the weakest performing maturity, losing 18/32 in price on the day. Its yield bumped up to 3.72 percent from 3.69 percent late on Thursday.

“The Fed is trying to introduce inflation so that hurts the long end of the curve,” Wells Fargo’s Rehling said.

The gap between two-year and 10-year yields grew to 2.09 percentage points from Thursday’s 2.06 points, suggesting less pessimism on U.S. growth and deflation risk.

Looking ahead, analysts expect choppy trading for Treasuries in advance of the government’s payroll report next Friday. A resurgence in job cuts would stoke bets that the Fed will press ahead with QE2 at its November policy meeting.

Some analysts said the Treasuries market has already priced a large-scale bond purchase by the Fed and may not rally much once the U.S. central bank announces such a move.

“Right now the market seems to be overdone,” said Michael Pond, Treasury strategist at Barclays Capital in New York. Pond estimated the market has priced in $600 billion to $700 billion worth of Treasuries purchase by the Fed.

Some analysts have predicted the Fed may buy up $1 trillion in Treasuries with the intend to stimulate investments and borrowing, which have been lacking during this recovery.

Additional reporting by Emily Flitter

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