TREASURIES-US bonds edge higher, still in holding pattern as caution persists

By Gertrude Chavez-Dreyfuss

NEW YORK, Oct 20 (Reuters) - U.S. Treasuries were modestly bid on Monday, with yields edging lower and trading held within tight ranges amid improving risk sentiment as the China trade outlook appeared less dire than it did weeks earlier.

Investors remained broadly cautious, however, as the federal government stayed shuttered for a 20th consecutive day, with no real compromise expected from either Republicans or Democrats.

But White House economic adviser Kevin Hassett said on Monday the shutdown could likely end this week. He said his "friends in the Senate" believed it was "bad optics for Democrats to open the government before the 'No Kings' rallies and that now there's a shot that this week things will come together."

In morning trading, the benchmark 10-year yield slipped 1.2 basis points (bps) to 3.999% US10YT=RR, while 30-year bond yields drifted lower to 4.583% US30YT=RR.

On the shorter end of the curve, U.S. two-year yields, which reflect interest rate expectations, were flat at 3.468% US2YT=RR.

"There is some better sentiment on China and trade that it's not going to spiral into a nightmare," said Stan Shipley, managing director and fixed income strategist at Evercore ISI.

U.S. Treasury Secretary Scott Bessent said on Friday he expects to meet this week with Chinese Vice Premier He Lifeng in Malaysia to try to forestall an escalation of U.S. tariffs on Chinese goods that President Donald Trump said was unsustainable.

Trump also confirmed he would meet with Chinese President Xi Jinping in two weeks in South Korea and expressed admiration for the Chinese leader.

But despite some China optimism, Evercore's Shipley noted that there is still a lot of anxiety in the market about the shutdown. He added that even though White House adviser Hassett said the shutdown could end this week, "my understanding of what he said is that if it doesn't end this week, (President) Trump is going to impose harsher measures."

Investors are also looking forward to the release of the September Consumer Price Index report on Friday that should give some perspective as to where inflation is headed.

"While the inflation data will contribute to the Fed's messaging at its upcoming meeting, it won't change the outcome of the rate decision," wrote BMO analysts in a research note.

"CPI won't deter a rate cut this month even if the core measure prints at the top of the range of economist estimates," the bank said. The consensus forecast for core CPI last month was 0.3%, unchanged from August, an estimate that reinforces "the limited inflationary fallout from the trade war thus far," BMO said.

In other parts of the bond market, the yield curve has bull flattened on Monday with the gap between U.S. two-year and 10-year yields at 52.6 bps US2US10=TWEB, from 55 bps late Friday.

A bull flattening refers to a curve in which long-term interest rates are falling faster than those on the short end, which reflects either a flight to safety or a lowering of inflation expectations. In any case, a bull flattener often precedes an interest rate cut from the Fed.