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CORRECTED-TREASURIES-U.S. bond prices steady as inflation stays tame

Richard Leong
Friday, 13 Dec 2013 | 11:04 AM ET

(Corrects the third paragraph to read $3 trillion, not $3 billion)

* Producer price data suggest U.S. inflation stays muted

* U.S. 2-year yield falls below 100-day moving average

* Shorter-dated yields rise on week, longer-dated yields fall

* U.S. to buy long-dated Treasuries for a 3rd time this week

NEW YORK, Dec 13 (Reuters) - U.S. Treasuries prices held steady on Friday, supported by news that domestic inflation remained tame, reviving hopes the Federal Reserve will not reduce its bond purchase stimulus program next week. Still traders remained on edge over the possibility of the Fed tapering its third round of quantitative easing that added over $1 trillion to its balance sheet when the policy-making body meets, traders and investors said. All three rounds of accommodation have added more than $3 trillion to the Fed's balance sheet. The Labor Department said its index on producer prices fell for a third straight month, dipping 0.1 percent in November. Analysts polled by Reuters had forecast the PPI index likely held at its October level last month. The PPI core rate, which excludes volatile food and energy prices, edged up 0.1 percent - in line with economists' expectation. On a year-over-year basis, it grew 1.3 percent, supporting the view that domestic inflation is running below the Fed's desired level of 2 percent. "The PPI showed very little inflation so the Fed has room to be patient with tapering," said Mike Cullinane, head of Treasuries trading at D.A. Davidson in St. Petersburg, Florida. Fed policy-makers who will meet Tuesday and Wednesday have worried this meager pace of price growth might deteriorate into a broader price decline that could devastate the U.S. economy for years akin to what happened in Japan in the 1990s. On the open market, benchmark 10-year Treasury notes were little changed in price, yielding 2.868 percent. On the week, the 10-year yield was on track to dip about 1 basis point although it was still within striking distance of the three-month high set a week ago due to a fairly robust jobs report in November. The 30-year bond gained 11/32 in price for a yield of 3.879 percent, down 2 basis points from late on Thursday. On the week, the 30-year yield was on track to fall 4 basis points. Short-dated issues stabilized after their yields broke above key support levels on Thursday, suggesting anxiety how long the Fed will keep policy rates near zero after it stops buying bonds, currently at a monthly pace of $85 billion. The Fed is scheduled at 11 a.m. (1600 GMT) to buy $1.25 billion to $1.75 billion in long-dated Treasuries, its third such purchase for the QE3 program this week. Two-year yield was last 0.330 percent, unchanged on the day after it traded to an eight-week high on Thursday and pierced above its 100-day moving average. While U.S. central bankers consider how to maintain price stability - one of the Fed's dual mandates next week , they have seen encouraging signs on the labor front with the recent pickup in monthly job creation. Improving employment conditions, together with resilience in the housing and manufacturing sectors in the aftermath of a 16-day government shutdown in October, have raised expectations the Fed is gearing for an exit from QE3 in 2014. Thirty-two economists expect the Fed to taper its third round of quantitative easing in March, while 22 said it would scale back its bond-buying program in January, according to a Reuters poll released on Wednesday. Only 12 economists expected a tapering announcement next week. "The big picture is that tapering is coming whether it's December, January or March. The economy is strong enough to remove the crutch of bond buying," said Cliff Corso, chief executive officer at Cutwater Asset Management in Armonk, New York. Encouraging fiscal development from Washington this week also caused some traders to believe the Fed will opt to taper sooner rather than later. Late Thursday, the U.S. House of Representatives passed a proposal for a two-year budget deal that will stave a government shutdown in January and mitigate automatic spending cuts.

(Reporting by Richard Leong; Editing by Theodore d'Afflisio)