TREASURIES-US bonds fall as risk appetite rises on optimism about ending shutdown

By Gertrude Chavez-Dreyfuss

NEW YORK, Nov 10 (Reuters) - U.S. Treasuries fell on Monday, driving yields higher, as investors cheered news that lawmakers were making progress toward ending the longest federal government shutdown in history — a standoff that has begun to weigh on the world's largest economy.

The U.S. Senate on Sunday moved forward on a measure aimed at reopening the government, advancing a House-passed bill that will be amended to fund it until January 30 and include a package of three full-year appropriations bills.

Monday marked the 41st day of the federal government shutdown, which has furloughed thousands of workers, disrupted food aid programs, and impacted national parks and travel.

Staffing shortages in air traffic control have also raised concerns about potential travel chaos during the busy Thanksgiving holiday later this month.

"The market sold off just because, with the shutdown ending, things should normalize a bit," said Tom di Galoma, managing director of rates and trading at Mischler Financial in Park City, Utah.

"We can reopen things and start getting some data, although I did see a note from one of the dealers that indicated that we may not see any October data ... because there's such a backlog, so they just have to kind of work on the new data for November."

In late morning trading, the benchmark 10-year Treasury yield was up 1.1 basis points at 4.104% US10YT=RR, while the two-year yield, which reflects interest rate expectations, rose 1.9 bps to 3.576% US2YT=RR.

U.S. 30-year bond yields were little changed at 4.704% US30YT=RR.

The yield curve flattened a touch on Monday, as the spread between U.S. two-year and 10-year yields fell to 52.4 bps US2US10=TWEB, from 53.3 bps late on Friday.

The curve showed a bear flattening pattern, with short-term yields rising faster than long-term rates, suggesting that the Fed may have to pause its cutting cycle given higher inflation expectations.

Since the Fed last cut interest rates on October 29, several U.S. central bank officials have come out and preached caution on cutting interest rates further.

Fed Chair Jerome Powell had said at the conclusion of that Fed meeting that easing in December was not assured amid policymakers' sharply divided views on the economic outlook and monetary policy.

On Monday, more Fed officials voiced the possibility of a pause in rate cuts at next month's policy meeting.

St. Louis Fed President Alberto Musalem said with inflation closer to 3% than the central bank's 2% goal, the economy resilient, financial conditions accommodative and monetary policy close to neutral, the Fed should "tread with caution" on any further interest rate cuts.

San Francisco Fed President Mary Daly, in an essay on Monday, said the central bank now needs to assess if the U.S. is still at risk of a breakout of inflation and needs to keep policy somewhat tight or is on the verge of a productivity boom driven by artificial intelligence that could fuel growth without a rise in prices.

"The Fed is still very unsure whether or not they're going to do anything in December," said Mischler's di Galoma. "The percentage of a 25 basis-point rate cut is around 68%. So it's high, but not high enough to ensure a 25 basis-point cut."

Also on Monday, the U.S. Treasury is set to auction $58 billion in three-year notes, scheduled earlier than usual due to the Veterans Day holiday on Tuesday.

"It's ... not wasted on us that the schedule creates an ideal backdrop for a four-day weekend for investors that won't be participating in the three-year auction," wrote BMO rates analysts in a research note.

The department is also set to sell U.S. six-week, 13-week, and 26-week bill auctions totaling $258 billion in supply.