TREASURIES-Two-year yields heading for largest monthly drop in a year

By Karen Brettell

Aug 29 (Reuters) - U.S. Treasuries were mixed on Friday and interest rate-sensitive two-year yields were on track for their largest monthly drop in a year as traders squared positions ahead of Monday’s Labor Day holiday and after inflation data for July met economists’ expectations.

The Personal Consumption Expenditures (PCE) Price Index increased 0.2% last month after an unrevised 0.3% rise in June, data on Friday showed. Excluding the volatile food and energy components, the PCE Price Index increased 0.3% last month, matching the rise in June.

The data keeps the Federal Reserve on track to cut rates at its September 16-17 meeting.

“You can check this off as one more risk to potentially derailing a cut in September. The inflation part of it, at least in this measure, is not going to do anything to reduce odds of a cut in September,” said Michael Lorizio, head of U.S. rates trading at Manulife Investment Management in Boston.

Fed funds futures traders are now pricing in 89% odds of a cut next month, up from 84% before the data.

U.S. consumer spending increased by the most in four months last month. A separate report from the University of Michigan showed consumers' one-year inflation expectations jumped to 4.8% in August from 4.5% in July.

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

Efforts by President Donald Trump to fire Fed Governor Lisa Cook have raised the prospect that Trump could make more dovish appointments to the U.S. central bank that would result in easier policy.

A court hearing on Trump's attempt to fire Cook ended on Friday with no immediate ruling from the judge, meaning that Cook will remain in place for now.

Longer-dated yields edged higher on Friday as traders closed positions ahead of the long weekend and repositioned for month-end.

Some interest rate hedging was also likely influencing the market with corporate debt markets expected to pick up next week when many people return from summer vacations.

“We have a very busy week coming up ... with primary markets and all the spread product markets returning in full force, especially the corporate bond market,” said Lorizio.

Jobs data for August is also due next Friday, which may be key in determining near-term Fed policy.

The 2-year note US2YT=RR yield was last down 1.6 basis points on the day at 3.619%. It has fallen 33 basis points this month, the most since last August.

The yield on benchmark U.S. 10-year notes US10YT=RR rose 1.6 basis points to 4.223%.

The yield curve between two-year and 10-year notes US2US10=TWEB was last at 60 basis points. It has steepened by 18 basis points this month, the most since April.