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TREASURIES-U.S. yields drop to three-month lows as markets prep for smaller Fed hikes

 (Adds comment, bullets, updates prices)

      U.S. 5-year to 30-year yields hit three-month lows

      Focus on Fed policy meeting next week

      Fed pause is best chance for soft landing -analyst

    By Gertrude Chavez-Dreyfuss
       NEW YORK, Dec 7 (Reuters) - 
    U.S. Treasury yields from five-year notes to 30-year bonds
fell to three-month lows on Wednesday in choppy trading, with
few market drivers this week, as investors doubled down on bets
that interest rates have likely peaked and inflation has
        "We have been kind of in a strong rally and we haven't
been given much of a pullback to get in," said Ellis Phifer,
managing director of fixed income research at Raymond James in
Memphis, Tennessee.
        "The bond market sees inflation waning; the Fed chair
also confirmed that the Fed is ... slowing and the bond market
is happier and bullish with that thought process."
        That said, strong November U.S. jobs data and generally
upbeat reports on manufacturing and services suggest the Fed
still has a long way to go to tame consumer and wage inflation
    Fed Chair Jerome Powell said late last month the U.S.
central bank could ease the pace of rate hikes "as soon as
December" but warned that the fight against inflation was far
from over.
    That has prompted the market to price in a lower terminal
rate, or the peak rate at which the Fed will stop hiking. Fed
funds futures showed that the peak rate on Wednesday was 4.9%,
down from 5.1% last week before Powell spoke.
    U.S. Treasury rates trended lower as well, with the U.S.
benchmark 10-year yield dropping 38 basis points
(bps) since Powell's remarks on Nov. 30.
    The U.S. two-year yield, which typically reflects
interest rate expectations, has fallen nearly 31 bps since then.
    "The market was very short (Treasuries) heading into
December and they're getting less short now after the last CPI
(consumer price index) report," said Gennadiy Goldberg, senior
rates strategist at TD Securities in New York.
    "There's a lot of uncertainty out there and that's why we're
seeing this daily chop because investors don't really know what
to do next."
    A widely tracked part of the U.S. Treasury yield curve
measuring the gap between yields on two- and 10-year notes
 deepened its inversion to -85.20, the most in two
weeks. The inversion of this curve typically precedes recession.
    In afternoon trading, the yield on 10-year notes
was down 9.8 bps at 3.415%. Earlier in the session, it fell as
low as 3.402%, the lowest since September.
    U.S. 30-year bond yields slid 10.1 bps to
3.422%, after sinking to 3.412%, a three-month trough.
    On the shorter-end of the curve, the two-year
U.S. Treasury yield fell 9.8 bps to 4.262%. 
        The breakeven rate on five-year U.S. Treasury
Inflation-Protected Securities (TIPS) retreated to
2.3796% from 2.443% on Tuesday, suggesting inflation will
average roughly 2.3% over the next five years. Since Nov. 7,
five-year breakevens have fallen around 25 bps.
    The 10-year TIPS breakeven rate was last at
2.278%, down from Tuesday's 2.339%.
        The Fed is widely expected to raise rates by 50 bps next
        "I think the Fed is going to do 50 (bps) in the next two
meetings and then maybe pause and see what happens," Raymond
James' Phifer said.
        "As long as inflation does not trend higher again, the
Fed could be on pause and just wait for other data. That's the
Fed's best chance to get a soft landing."
        December 7 Wednesday 4:27PM New York / 2127 GMT
                               Price        Current   Net
                                            Yield %   Change
 Three-month bills             4.19         4.2937    -0.077
 Six-month bills               4.535        4.7059    -0.032
 Two-year note                 100-111/256  4.2685    -0.092
 Three-year note               101-96/256   3.9982    -0.094
 Five-year note                101-24/256   3.6327    -0.101
 Seven-year note               101-252/256  3.5513    -0.096
 10-year note                  105-220/256  3.4241    -0.089
 20-year bond                  104-172/256  3.6674    -0.091
 30-year bond                  110-152/256  3.4309    -0.092
   DOLLAR SWAP SPREADS                                
                               Last (bps)   Net       
 U.S. 2-year dollar swap        32.25         1.50    
 U.S. 3-year dollar swap        11.25         1.00    
 U.S. 5-year dollar swap         3.75         2.00    
 U.S. 10-year dollar swap       -3.25         2.25    
 U.S. 30-year dollar swap      -38.50         2.75    
 spread (Reporting by Gertrude Chavez-Dreyfuss; Editing by Elaine
Hardcastle and Richard Chang)