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Bonds Trim Losses as Ambac News Drives Stocks Lower

US government debt prices trimmed losses on Wednesday as stocks turned lower on a decline in bank shares, restoring some of Treasurys' safe-haven allure.

The benchmark 10-year note's price -- which moves inversely to its yield -- traded off its lows but down 6/32 for a yield of 3.67 percent, compared with 3.63 percent late on Tuesday.

The two-year note traded up 2/32 in price for a yield of 1.64 percent, compared with 1.67 percent late on Tuesday.

Record commodity prices, with oil breaking above $104 a barrel and gold approaching $1,000 an ounce, stoked inflation fears and had put pressure on bond prices.

Treasury prices hit session lows on news that Ambac Financialhad reached a deal to shore up its capital, raising hopes the beleaguered bond insurance industry was finding a way out of the subprime mess. The tide turned for Ambac when it announced it was selling $1.5 billion in stock and equity-linked securities to raise capital, sending shares plummeting.

Bond investors focused on the report on the service sector, which contracted for a second straight month in February, according to the Institute for Supply Management. However, the ISM reading was not as weak as expected and reversed a safe-haven bid for bonds after a private sector report showed a surprise loss of jobs in February.

The latest ISM data also energized the stock market with the three major indices rising as much as 1 percent.

"The clear catalyst was the ISM service data being not as bad as people had thought," said Jason Brady, portfolio manager with Thornburg Investment Management in Santa Fe, N.M.

The decline in bond prices was curbed by inflow into Treasurys from leveraged accounts which have been selling high-risk assets to raise money to meet redemptions, analysts and investors said.

Lower Rate-Cut Expectations

Traders were less enthusiastic about the prospects of the Fed dropping the federal funds target rate by 75 basis points to 2.25 percent this month, following the service sector report.

According to interest rate futures, traders now see a 50 percent chance of such an aggressive cut, down from 78 percent overnight.

While the ISM service report overshadowed the day's more dire economic data, traders are placing greater emphasis on the government's non-farm payroll survey, the month's premier economic report which will be released on Friday.

Analysts said the ADP job report has raised the risk that company payrolls shrank for a second straight month, supporting the view that a weakening labor market would tip the United States into a recession.

The median forecast on February payrolls was a 25,000 increase, compared with a 17,000 drop, according to economists polled by Reuters. Some of them have lowered their forecasts after the weak ADP data.

The Fed will round out Wednesday's heavy calendar of economic data with the release of its Beige Book at 2 p.m.

It contains snapshots of regional economic conditions, which Fed policy-makers will discuss when they meet on March 18.

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