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TREASURIES-U.S. bond market rallies on North Korea jitters

* October T-bill yields elevated on debt ceiling concerns

* Companies seen selling $35 bln-$40 bln in high-grade debt -IFR

* Fed should be cautious as inflation stays weak -Brainard

(Updates market action, adds quote) NEW YORK, Sept 5 (Reuters) - The U.S. Treasuries market rallied on Tuesday with the 10-year yield hitting a near 10-month low as worries about further nuclear tests by North Korea spurred safe-haven demand for U.S. government debt.

Yields on Treasury bills due in October remained elevated as investors await developments on whether U.S. lawmakers would reach a deal to increase the federal debt ceiling in a bid to avert a default. "Right now the safe-haven bid is clearly in place as North Korea did a 'H-bomb' test over the weekend," said Larry Milstein, head of government and agency trading at R.W. Pressprich & Co in New York. On Sunday, North Korea said it tested an advanced hydrogen bomb for a long-range missile, prompting global condemnation and a U.S. warning of a "massive" military response if it or its allies were threatened. Traders and analysts said the decline in U.S. yields was partly offset by hedging activity tied to an expected $35 billion to $40 billion worth of investment-grade corporate bond supply to hit this week according to IFR, a Thomson Reuters unit. Meanwhile, Federal Reserve Governor Lael Brainard said the U.S. central bank should be cautious about raising interest rates further as inflation has been stuck below its 2 percent goal. On the other hand, Brainard suggested she was prepared to back the announcement of the Fed's plan to announce a reduction of its $4.2 trillion portfolio of bond holdings at its upcoming Sept. 19-20 policy meeting. At 12:19 p.m. (1619 GMT), the yield on benchmark 10-year Treasury notes was down 8 basis points at 2.082 percent. Earlier on Tuesday it hit 2.079 percent, which was its lowest level since Nov. 10. U.S. financial markets were closed on Monday for the Labor Day holiday. The yield on T-bills due on Oct. 5, the first debt issue that the government might skip repaying if the debt ceiling is not raised before a late September deadline, was at 1.205 percent, down 4 basis points from late on Friday. Top Republicans and Democrats have hinted they would at least arrive at a temporary agreement to fund the government and increase the federal borrowing limit to prevent a shutdown and a default. "All the top leaders in Congress from both parties seem to say the debt ceiling is not an issue," said Mike Lorizio, head of Treasuries trading at Manulife Asset Management in Boston. September 5 Tuesday 12:22PM New York / 1622 GMT Price

US T BONDS DEC7 156-23/32 1-17/32 10YR TNotes DEC7 127-84/256 0-168/25

6

Price Current Net Yield % Change

(bps)

Three-month bills 0.99 1.0061 -0.005 Six-month bills 1.0825 1.1034 0.007 Two-year note 99-232/256 1.298 -0.048 Three-year note 100-74/256 1.3992 -0.060 Five-year note 99-216/256 1.6578 -0.075 Seven-year note 99-202/256 1.9074 -0.079 10-year note 101-128/256 2.0821 -0.075 30-year bond 100-252/256 2.7018 -0.066

DOLLAR SWAP SPREADS

Last (bps) Net

Change (bps)

U.S. 2-year dollar swap 22.00 1.50

spread

U.S. 3-year dollar swap 19.25 1.25

spread

U.S. 5-year dollar swap 6.50 0.75

spread

U.S. 10-year dollar swap -5.00 0.25

spread

U.S. 30-year dollar swap -34.50 0.25

spread

(Reporting by Richard Leong; Editing by Meredith Mazzilli and Paul Simao)