* Producer price data suggests U.S. inflation stays muted
* Better economic data reinforces idea Fed will trim purchases in 2014
* U.S. 2-year yield falls below 100-day moving average
* Fed bought $1.58 billion Treasuries due 2038-2043
NEW YORK, Dec 13 (Reuters) - Long-dated U.S. Treasuries prices rose on Friday as the yield curve flattened amid muted inflation. The subdued inflation data reinforced the idea that the Federal Reserve would not reduce bond purchases aimed at stimulating the economy until 2014. The stronger performance followed losses on Thursday due to slightly stronger than expected November retail sales and a poor $13 billion auction of 30-year bonds, the final part of this week's $64 billion in coupon-bearing supply. Traders were watching to see what the Fed says about the fate of its third round of quantitative easing when its policy-setting committee meets next week. "Will the Fed start reducing its purchases next week? No. Absolutely not. But there's been enough good economic data to justify some purchases at the long end of the yield curve," said Paul Montaquila, vice president and fixed-income investment officer, at Bank of the West's capital markets division in San Francisco. The latest purchase program has added over $1 trillion to the Fed's balance sheet. 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 PPI 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 that meager price increases put the economy at risk of deflation, a phenomenon that tends to slow economic activity.
On the open market, benchmark 10-year Treasury notes rose 2/32 in price, leaving their yields at 2.88 percent. They ended last week at 2.84 percent. The 30-year bond rose 10/32 in price. Its yield eased to 3.88 percent, down for 3.90 percent late on Thursday, but up from 3.87 percent a week ago. "The PPI was pretty weak so the long-end bounced back," D.A. Davidson's Cullinane said. Short-dated issues stabilized after their yields broke above key support levels on Thursday, suggesting anxiety about 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 bought $1.575 billion in long-dated Treasuries due in May 2038 to February 2043, its third such purchase for the QE3 program this week. The two-year yield edged up to 0.330 percent from 0.326 percent late on Thursday. It traded to an eight-week high of 0.342 percent on Thursday, piercing above its 100-day moving average. Investors will face another wave of supply next week: $32 billion in two-year notes ; $35 billion in five-year debt ; $29 billion in seven-year notes and $16 billion in five-year Treasury Inflation-Protected Securities.
FASTER U.S. JOB GROWTH While U.S. central bankers consider how to maintain price stability, 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. An encouraging fiscal development in Washington 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 two-year budget deal that will stave off a government shutdown in January and mitigate automatic spending cuts.