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TREASURIES-U.S. 10-year yields hit 3-1/2-year high, shrug off shutdown

* 10-year yields hit highest since July 2014 before stabilizing

* U.S. government shutdown begins third day

NEW YORK, Jan 22 (Reuters) - Benchmark Treasury yields hit their highest in more than three years on Monday, as investors largely shrugged off a U.S. government shutdown, anticipating it will not have a significant long-term impact on the world's largest economy. Both Republicans - who control the White House and Congress - and Democrats are expected to face pressure to allay any economic pressure that results from the shutdown, so it is likely that most short-term federal spending cuts will be followed by added spending in the future. "I don't think the shutdown matters a lot," said Ward McCarthy, chief financial economist at Jefferies LLC in New York. "It would have more effect on the market if it were intertwined with the debt ceiling, but for the time being that does not appear to be the case," he added. Hundreds of thousands of federal workers began shutting down operations on Monday, as a bipartisan group of senators tried to negotiate a deal just hours before the full Senate planned another vote on restoring funding for the federal government. The shutdown began at midnight on Friday. Benchmark government yields hit 2.672 percent, the highest since July 2014, but was last at 2.643 percent, slightly higher from Friday's 2.639 percent. The 10-year maturity on Friday broke through its 2017 high of 2.64 percent, a key technical support level. Reaching that key technical level means that yields at or below 2.64 percent may indicate the market will hold those rates in the near term. If they move above that level, the market will probably test the next highest mark of 2.710 percent, or 2.808 percent, which offers the strongest support in a sell-off. On Monday morning the market had "a little bit of a bounce from last Friday, which was a pretty ugly day," said Jefferies' McCarthy, before the sell-off slowed. If Congress fails to pass a funding bill by the end of January, the biggest economic impact of the shutdown will be on the Federal Reserve. Data collection by agencies such as the Bureau of Labor Statistics may be disrupted and therefore make the final reported results for the period inaccurate. What's more, "a Fed that hikes despite a missing or unreliable nearby inflation or employment print(s) will choreograph a much steeper reaction function than it may intend to," said a note by Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets in New York. This week's schedule of data releases is light until Friday, when the first estimate of fourth-quarter gross domestic product will be reported. In mid-morning trading, the U.S. 2-year note yield was at 2.061 percent, after hitting 2.082 percent earlier in the day, its highest since September 2008.

January 22 Monday 10:03AM New York / 1503 GMT Price

US T BONDS MAR8 148-26/32 -0-6/32 10YR TNotes MAR8 122-52/256 -0-20/25

6

Price Current Net Yield % Change

(bps)

Three-month bills 1.41 1.4344 0.000 Six-month bills 1.595 1.6299 0.005 Two-year note 99-162/256 2.0691 0.008 Three-year note 99-108/256 2.2015 0.011 Five-year note 98-130/256 2.4476 0.012 Seven-year note 97-236/256 2.579 0.010 10-year note 96-144/256 2.65 0.011 30-year bond 96-156/256 2.921 0.009

DOLLAR SWAP SPREADS

Last (bps) Net

Change (bps)

U.S. 2-year dollar swap 19.75 0.00

spread

U.S. 3-year dollar swap 19.00 -0.25

spread

U.S. 5-year dollar swap 6.75 -0.75

spread

U.S. 10-year dollar swap 3.00 -2.50

spread

U.S. 30-year dollar swap -13.25 -2.50

spread

(Reporting by Kate Duguid; Editing by Frances Kerry)