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TREASURIES-U.S. yields drop as U.S.-China trade row feeds bond rally

Richard Leong

* Treasuries record best week since November 2011 U.S. services sector growth slowest in three years -ISM

* Futures imply traders fully expect Fed rate cut in September

* U.S. to sell $84 bln in coupon-bearing debt this week

(Updates market action) NEW YORK, Aug 5 (Reuters) - U.S. Treasury yields tumbled on Monday, with 10-year yields hitting their lowest level since November 2016, as fears over escalation of U.S.-China trade tensions renewed concerns about an economic downturn, spurring another dramatic rally for bonds. China allowed the yuan to breach the key seven-per-dollar level for the first time in more than a decade, in a sign Beijing might be willing to tolerate more currency weakness that could further inflame the trade conflict with the United States. Chinese state media said local firms have halted their purchases of agricultural products, elevating nervousness the world's two biggest economies are going toe-to-toe in their trade dispute. These measures followed U.S. President Donald Trump's threat last week to impose 10% tariffs on $300 billion of Chinese imports starting Sept. 1. "There's a lot of fears out there," said Larry Milstein, head of government and agency trading at R.W. Pressprich & Co. in New York. "What is the path that could end this? It doesn't seem we are going to get there anytime soon." The growing trade friction between the world's two biggest economies appeared to begin hurting the U.S. services sector on top of the squeeze on domestic manufacturers. The Institute for Supply Management's index on U.S. services activity showed the vast economic sector's growth slowed to its weakest level in three years in July. Anxious investors have been bailing from stocks and other risky assets with Wall Street's main stock indexes falling 2%.

They have favored U.S. government debt, the yen, gold and other perceived low-risk assets to park their money. The Treasuries market recorded a total return of 1.31% last week, which was its biggest weekly gain since November 2011, according to an index compiled by Bloomberg and Barclays. At 1:47 p.m. (1747 GMT), the yields on benchmark 10-year Treasury notes were down 12.4 basis points at 1.7311%. They hit 1.729% earlier on Monday, which was their lowest since Nov. 9 2016, the day after Trump was elected president. The two-year yield, which is sensitive to traders' view on Fed policy, touched 1.577%, its lowest since November 2017. It was last 14.3 basis points lower at 1.5793%. Interest rates futures implied traders fully expect the U.S. central bank will lower rates again at its Sept. 17-18 policy meeting after it cut them for the first time since 2008 last week, CME Group's FedWatch program showed. The difference between the three-month Treasury bill rate and 10-year yields grew to nearly 27 basis points, the widest since April 2007. This curve "inversion" between the two maturities has preceded every U.S. recession in the past 50 years. Meanwhile, the blistering demand for Treasuries is expected to stoke bids for this week's quarterly refunding where the government will sell $38 billion in three-year debt, $27 billion in 10-year notes and $19 billion in 30-year bonds.

Monday, Aug. 5, at 1348 EDT (1748 GMT): Price

US T BONDS SEP9 160-25/32 70/3210YR TNotes SEP9 129-224/256 33/32Price Current NetYield % Change

(bps)

Three-month bills 1.97 2.0123 -0.052Six-month bills 1.9425 1.9885 -0.027Two-year note 100-85/256 1.5793 -0.143Three-year note 100-154/256 1.5398 -0.139Five-year note 101-12/256 1.531 -0.139Seven-year note 101-174/256 1.6196 -0.13110-year note 105-196/256 1.7311 -0.12430-year bond 112-144/256 2.2906 -0.101YIELD CURVE Last (bps) Net

Change (bps)

10-year vs 2-year yield 15.00 1.9030-year vs 5-year yield 76.00 3.80

DOLLAR SWAP SPREADS

Last (bps) Net

Change (bps)

U.S. 2-year dollar swap -0.25 -2.75

spread

U.S. 3-year dollar swap -4.50 -3.25

spread

U.S. 5-year dollar swap -6.00 -2.25

spread

U.S. 10-year dollar swap -10.75 -2.25

spread

U.S. 30-year dollar swap -42.00 -3.50

spread

(Reporting by Richard Leong Editing by Steve Orlofsky, Paul Simao and Susan Thomas)