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Treasurys rally takes a pause as ECB meeting looms

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Treasurys were steady on Friday, pausing a week-long rally, as investors remained focused on next week's highly anticipated European Central Bank meeting.

Benchmark 10-year Treasury notes were 3/32 lower in price with the yield at 2.35 percent on Friday. Thirty-year notes fell 7/32 in price and yielded 3.09 percent.

Comments by ECB President Mario Draghi last Friday were interpreted by some market participants as indicating that the central bank had changed forecasts on inflation lower, and that it may be more likely to embark on new quantitative easing to stave off a decline.

That has helped German goverment bond yields plunge to record lows, pulling Treasurys yields also lower with them.

But others say that such a move by the ECB is unlikely and market gauges that central banks watch, such as five-year, five-year forward breakeven inflation rates, still indicate inflation to be near the central bank's 2 percent target in the future.

Treasurys are likely to continue following European bonds next week, with a risk that disappointment after the ECB meeting could send yields higher.

"If the market rallied in Europe because he was going to do it does the backend in Europe sell off hard because he hasn't done it?,'' said Richard Gilhooly, an interest rate strategist at TD Securities in New York.

"Even if he doesn't do anything next week he's still going to talk about what they will do, and get the market bulled up on that,'' Gilhooly added.

German Finance Minister Wolfgang Schaeuble said in comments published on Friday that the central bank has run out of tools to fight deflation, and that liquidity in markets may be too high.

Treasurys also gained a safety bid after Britain raised its terrorism alert to the second-highest level with Prime Minister David Cameron saying the Islamic State (IS) group operating in Syria and Iraq posed the country's greatest ever security risk.

Month-end buying also added to demand for U.S. bonds.

"There are no sellers, (the market) is bid and its been bid for some time,'' said Charles Comiskey, head of Treasurys trading at Bank of Nova Scotia in New York.

The ECB meeting and geopolitical concerns including tensions in Ukraine are likely to remain the market's focus next week even as next Friday's U.S. employment report for August comes into view.

—By Reuters