TREASURIES-Two-year yields stay close to lows as traders prepare for rate cuts

By Karen Brettell

NEW YORK, Aug 28 (Reuters) - Interest rate-sensitive two-year yields rose on Thursday but held near an almost four-month low as traders bet that the Federal Reserve will make several interest rate cuts in the coming months as the labor market shows signs of weakness.

The slight backup in yields on Thursday was seen as profit-taking after a strong rally and some month-end repositioning, rather than changing expectations on Fed policy.

Traders ramped up bets on more cuts after Fed Chair Jerome Powell on Friday adopted an unexpectedly dovish tone and said risks to the job market were rising.

Investors are also evaluating whether U.S. President Donald Trump will be able to make more appointments to the Fed and then tilt it in a more dovish direction. Trump has repeatedly criticized Powell for being too slow to cut rates.

Fed Governor Lisa Cook on Thursday filed a lawsuit saying Trump has no power to remove her from office. Trump earlier this week said he was firing Cook due to alleged "deceitful and potential criminal conduct" related to mortgages she took out in 2021.

“The big driver is the Fed story. Bond markets love rate cuts,” said Padhraic Garvey, regional head of research, Americas, at ING.

“The front end of the curve is absolutely expecting the funds rate to get cut by 150 basis points, which is the number that Scott Bessent has suggested is what the Fed should be doing,” Garvey added.

Treasury Secretary Bessent said this month that “rates are too constrictive ... We should probably be 150 to 175 basis points lower," which would take the fed funds rate near the 3% area that many analysts see as being the neutral rate.

Fed funds futures traders are pricing in 84% odds of a cut at the Fed’s September 16-17 meeting. In total, they see 137 basis points of cuts by the end of 2026.

The two-year note US2YT=RR yield was last up 1.4 basis points at 3.637%. The benchmark 10-year note US10YT=RR fell 0.8 basis points to 4.23%.

The yield curve between two-year and 10-year notes US2US10=TWEB was last at 59 basis points, after reaching 62.5 basis points on Wednesday, which was the steepest level since April 22.

Longer-dated debt has not kept up with the rally in shorter-dated notes this week, and the yield curve has steepened, due to concerns about the potential impacts of looser Fed policy.

A politically influenced Fed that keeps interest rates lower than they otherwise might could result in higher inflation and reduce foreign demand for the debt due to credibility fears.

A worsening fiscal outlook is also expected to continue to weigh on longer-dated debt.

Data on Thursday showed that the number of Americans filing new applications for jobless benefits fell last week.

A separate report showed that GDP increased at a 3.3% annualized rate last quarter, after the economy was initially reported to have grown at a 3.0% pace in the second quarter.

This week’s main economic release will be Personal Consumption Expenditures on Friday. The U.S. bond market will be closed on Monday for the Labor Day holiday.

The Treasury Department will sell $44 billion in seven-year notes on Thursday, the final sale of $183 billion in short- and intermediate-dated supply this week.

The U.S. government saw decent demand for a $70-billion sale of five-year notes on Wednesday and strong demand for a $69-billion sale of two-year notes on Tuesday.