Bonds Inch Higher but 'Cliff' Paralysis Caps Gains

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U.S. Treasuries gained in price on Wednesday, erasing losses sustained in Asian trading, 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.

Spain sold 4.25 billion euros of bonds compared with a maximum target of 4.5 billion euros, leading to a sell-off in its debt markets and lifting assets perceived as safe havens such as German Bunds and U.S. Treasuries.

Price gains were capped however as many investors stayed on the sidelines amid uncertainty over how U.S. lawmakers will address a fiscal crunch of spending cuts and tax hikes scheduled for the new year, also known as the looming "fiscal cliff". If it is not addressed, many observers expect it will likely hurt the economy.

"The markets are paralyzed by the fiscal cliff," said Scott Graham, head of U.S. government bond trading at BMO Capital Markets in Chicago.

Bonds were little moved by data that showed that U.S. private-sector employers added 118,000 jobs in November, just shy of economists' expectations, according to ADP National Employment Report.

Investors are now closely focused on Friday's 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 Graham.

Benchmark 10-year notes were last up 4/32 in price to yield 1.59 percent, down from 1.61 percent late on Tuesday. The Federal Reserve will buy between $4.25 billion and $5.25 billion in notes due 2021 and 2022 on Wednesday as part of its Operation Twist program.