December 5, 2017 / 8:13 PM / a year ago

TREASURIES-U.S. short-term yields hit multi-year highs, yield curve flattens on Fed bets

    * U.S. two-year yields hit highest since 2008
    * Three-year yields hit highest since 2009
    * Five to 30-year yield curve flattest since 2007

 (Updates to U.S. afternoon trading, adds quote)
    By Dion Rabouin
    NEW YORK, Dec 5 (Reuters) - Short-dated U.S. Treasury yields
rose to their highest in more than eight years on Tuesday as
investors increasingly expected  the U.S. Congress to pass tax
reform legislation and the Federal Reserve to raise interest
rates several times next year.
    The yield on the two-year note touched its highest since
October 2008 and the three-year note yield hit its highest since
June 2009.
    The yield curve flattened, with the difference between the
yields on five- and 30-year debt hitting its lowest in a decade
as yields on longer-dated Treasuries fell.
    Fed funds futures prices show that investors see a rate
increase at the U.S. central bank's Dec. 12-13 meeting as a
certainty and odds of bringing the U.S. overnight interest rate
to a range of 1.50-1.75 percent, a 50-basis-point hike, have
risen to nearly 10 percent. Futures prices show a zero percent
chance of rates remaining at their current level of 1.00-1.25
    The yield on two-year Treasury note           , the most
sensitive to Fed policy expectations, rose to 1.835 percent. The
three-year note yield            touched 1.95 percent.
    The spread between yields on the five-year Treasury note and
30-year bond dropped to 57.3 basis points, the narrowest since
October 2007.
    The 30-year bond rose 26/32 in price to yield 2.73 percent,
down around four basis points from its late Monday levels.
    Data released Tuesday showed the U.S. trade deficit
increased to a nine-month high in October because of rising oil
prices and the widening of America's long-standing deficits with
China and Mexico. Additionally, the Institute for Supply
Management (ISM) said its non-manufacturing index fell in
November, missing economists' expectations.
    Investors are pricing in multiple rate increases from the
Fed in response to strong U.S. employment data and a recent
pickup in inflation but see limited upside for long-term
inflation, even with passage of the proposed tax bill.
    "You get some exhaustion from the tax reform, knowing that
there’s still work to be done. There’s still other problems and
then you combine that with a little bit of underwhelming
economic information and that leads to a little bit of
retracement," said Justin Hoogendoorn, head of fixed income
strategy at Piper Jaffray & Co.
    Evercore ISI strategist Stan Shipley said investors also are
undervaluing the possibility of a U.S. government shutdown if
lawmakers cannot reach a budget accord this week. Government
funding is set to expire Friday.
    "Talking to international clients they are completely
oblivious to this," he said. "Issues on tax reform and Trump
have captured their attention and they’re not thinking about
what a shutdown could do."

 (Reporting by Dion Rabouin; Editing by Steve Orlofsky)
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