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Bonds Dip as Deeper Cut Seems Less Likely

U.S. Treasury debt prices eased on Monday, as investors pared bets for a more aggressive interest rate cut from the Federal Reserve absent any further deterioration in the economy.

Still, uncertainty over what the Fed might signal about the future when policy-makers meet on Tuesday limited the decline in bonds, leaving two-year notes down just 1/32 and yielding 4.07 percent.

Investors are still widely looking for a quarter percentage point reduction in the federal funds rate, the first in four years. But despite an August contraction in hiring, some analysts believed consumer spending was not yet weak enough to warrant more drastic action.

"What seems most likely is that the Fed will lower the funds rate by 25 basis points," said Tony Crescenzi, chief bond market strategist at Miller Tabak.

For a bond market that had been pricing in a rapid string of cuts, that possibility was enough to nudge prices lower.

Ten-year notes were off 2/32 and yielding 4.46 percent, down one basis point from Friday's close but nearly a full percentage point lower from a June high.

Apart from lower benchmark rates, analysts foresee another reduction in the discount rate aimed at revitalizing lethargic financial markets by inducing banks to borrow directly from the Fed.

The building consensus of what the Fed will do belied widespread disagreement regarding what officials might say in their post-meeting pronouncement.

Some believe the central bank will counter the rate cut with a renewed warning on inflation, but others think a looser policy stance will only be effective if it is accompanied by an implicit promise of further reductions down the line.

The drop in bond prices came despite losses in equities, which ordinarily spur some interest in safer securities like Treasurys.

Stocks were still reeling from the fallout of ailing British mortgage lender Northern Rock, which highlighted the continued troubles plaguing financial markets.

Yet two-year notes, whose yield remains more than a full percentage point below the overnight federal funds target, sold off 2/32 in price. The yield climbed to 4.08 percent from 4.05 percent.

The session's lone piece of economic data, a New York Fed survey of regional manufacturers, was just mixed enough to keep traders guessing.

Growth in the sector slowed more sharply than anticipated, but the employment index posted its highest reading this year, countering worries spurred by a rising trend in initial unemployment claims.

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