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TREASURIES-U.S. yields retreat, tracking Fed rate outlook

Gertrude Chavez-Dreyfuss

* U.S. service sector index comes in lower than expected

* U.S. yield curve flattens

* U.S. three-year note auction shows solid results

(Adds comment, updates prices) NEW YORK, Feb 5 (Reuters) - U.S. Treasury yields fell on Tuesday, with the 10-year sliding from one-week highs, as the market priced in the Federal Reserve's dovish interest rate view amid an uncertain global economic outlook. U.S. two-year yields also declined from one-week peaks, while 30-year yields dropped after rising for two straight days. "There's a little bit of intra-day volatility, but yields are consolidating around levels that are more consistent with the new position at the Fed," that it could effectively hold rates steady over the next six months, said John Herrmann, rates strategist at MUFG Securities in New York. The Fed last week struck a cautious tone on the U.S. economy, suggesting it will pause its rate-hike cycle, or even ease monetary policy if the economy warrants it. Many economists believe, however, the Fed could hike one more time this year. Herrmann believes the U.S. economy could decelerate this year as the Trump administration's fiscal initiatives run out. "Last year's strong economy is behind us." Data showing a weaker-than-expected U.S. service sector index of 56.7 affirmed a softer economic outlook, with new orders falling to a one-year low. "The weak international backdrop is clearly playing a role, with the new export orders index falling even more sharply," said Michael Pearce, senior U.S. economist, Capital Economics in New York. "We think this is a sign to come, as the impact of the Fed's rate hikes last year feeds through to economic activity, just as the boost from fiscal stimulus fades further," he added. Tuesday's auction of $38 billion in U.S. three-year notes, meanwhile, showed solid demand. The offering was priced at 2.502 percent, the lowest for this maturity at an auction since last April, Treasury data showed. There were $97.0 billion in bids for a 2.55 bid-to-cover ratio, a gauge of demand, which a little better than last month's weak 2.44. "Solid auction supports stronger short U.S. Treasury prices," said Jim Vogel, interest rates strategist, at FTN Financial in Memphis, Tennessee. "It's the first confirmation of 'new' Fed thinking since last Thursday." In afternoon trading, U.S. 10-year note yields fell to 2.70 percent, down from 2.724 late on Monday. U.S. 30-year bond yields were also down at 3.032 percent , from 3.06 percent on Monday. On the short end, U.S. 2-year yields were down at 2.524 percent, compared with Monday's 2.532 percent. The yield curve flattened a little on Tuesday, with the U.S. 10-year and U.S. 2-year note spread falling to 17.2 basis points, retracing auction-related steepening on Monday.

Tuesday, Feb. 5 at 1503 EST (2003 GMT):

Price Current NetYield % Change

(bps)

Three-month bills 2.37 2.4176 -0.010Six-month bills 2.4375 2.5022 -0.005Two-year note 99-243/256 2.5263 -0.006Three-year note 99-246/256 2.5136 -0.011Five-year note 99-234/256 2.5184 -0.016Seven-year note 100-32/256 2.6053 -0.01510-year note 103-140/256 2.7091 -0.01530-year bond 106-132/256 3.0406 -0.019

DOLLAR SWAP SPREADS

Last (bps) Net

Change (bps)

U.S. 2-year dollar swap 14.25 0.25

spread

U.S. 3-year dollar swap 10.75 0.25

spread

U.S. 5-year dollar swap 8.75 0.25

spread

U.S. 10-year dollar swap 2.25 0.00

spread

U.S. 30-year dollar swap -18.75 0.25

spread

(Reporting by Gertrude Chavez-Dreyfuss; Additional reporting by Richard Leong; Editing by Phil Berlowitz and Susan Thomas)