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Bonds Bid Up by Mounting 'Cliff' Fears

U.S government bonds gained in price on Wednesday as investors saw a diminishing likelihood that U.S. lawmakers will stave off a fiscal crunch of spending cuts and tax hikes scheduled for the new year, which are seen likely to hurt the economy.

Republican leaders in the U.S. House of Representatives said on Wednesday that talks with President Barack Obama to resolve the fiscal cliff were deadlocked, and they demanded a meeting with the president to move the negotiations forward.

Bonds accelerated price gains and benchmark 10-year note yields fell to their lowest levels in two weeks as stocks declined, adding to the bid for safe-haven debt.

"It seems to me that without some deal the market is going to stay bid and there's going to be a reach for yield. I think the probability of going off the fiscal cliff gets higher by the day," said Charles Comiskey, head of Treasury trading at the Bank of Nova Scotia in New York.

Bonds also gained as the Federal Reserve completed its latest bond purchases as part of its "Operation Twist" program. The Fed bought $4.75 billion in notes due 2021 and 2022 on Wednesday as part of Operation Twist, which designed to lower long-term borrowing rates.

Demand for U.S. government debt was boosted earlier after Spain failed to meet the maximum target at a debt auction, raising worries that demand for the euro zone sovereign's bonds was drying up.

Many economists expect Spain to eventually seek a bailout from its euro zone partners to cover for a jump in financing needs next year.

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Bonds were little moved after private payrolls processor ADP said U.S. private-sector employers added 118,000 jobs in November, just shy of economists' expectations.

Investors are now awaiting the release on Friday of government's more comprehensive monthly payrolls report for November, which is expected to show that employers added 171,000 jobs in the month, according to the median estimate of 92 economists polled by Reuters.

Reaction to Friday's data, however, may be limited as traders question the accuracy of the number, which is expected to be swayed by the effects of Superstorm Sandy on heavily populated states on the U.S. East Coast.

"I think the data right now is ancillary. There is going to be so much noise around unemployment as a result of Sandy," said Scott Graham, head of U.S. government bond trading at BMO Capital Markets in Chicago.

Next week's Federal Reserve policy meeting is also coming into view, with expectations that the Fed will announce a new round of quantitative easing.

"Everybody expects the Fed to announce they will continue Treasury purchases next year," after Operation Twist is due to expire, said Suvrat Prakash, interest rate strategist at BNP Paribas in New York.

Declining supply of longer-dated debt may lead the Fed to extend purchases to shorter-dated maturities than the current purchases of seven-year, 10-year and 30-year bonds.

"Are they going to have to go to the five-year sector in addition to the back-end? If you look at supply, they have kind of run out of room to buy the 10-year," said BMO's Graham.

Benchmark 10-year notes were last up 8/32 in price to yield 1.58 percent, down from 1.61 percent late on Tuesday.Thirty-year bonds gained 11/32 in price to yield 2.76 percent, down from 2.78 percent on Tuesday.

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