TREASURIES-U.S. yields slip ahead of Fed minutes, but underlying trend tilted to upside

By Gertrude Chavez-Dreyfuss NEW YORK, Feb 22 (Reuters) - U.S. Treasury yields fell on Wednesday after surging to three-month highs on Tuesday ahead of the release of the Federal Reserve minutes later in the session, with bond investors still expecting yields to go higher amid a spate of strong economic data. U.S. 10-year yields hit new three-month highs earlier on Wednesday, before coming down to trade 4.7 basis points lower at 3.915%. U.S. two-year yields , which reflect interest rate expectations, were also down on the day at 4.666%, after hitting three-month peaks in the previous session. St. Louis Fed President James Bullard, who is not a voter on the Federal Open Market Committee (FOMC) this year, on Wednesday reiterated his view that a Fed policy rate in the range of 5.25% to 5.5% would be adequate for the task. His rate assessment is in line with the rate futures market, which expects a peak fed funds rate of 5.34% hitting in July . "Treasury yields are marginally lower, but the underlying trend has been higher. If you go back to late December, people expected the economy to slip into recession this year," said Stan Shipley, fixed income strategist at Evercore ISI. "But with employment growth solid or robust and with inflation dishearteningly high and not coming down as fast as people expect, I think people are starting to scale back on recession expectations. So the 10-year yield should be trading with a four-handle," he added. Investors are looking to Wednesday's minutes of the Jan. 31-Feb. 1 FOMC meeting. The Fed minutes are expected to spell out the extent of the debate over how much further interest rates may need to rise to curb inflation and slow an economy that has remained stronger than expected despite tighter Fed policy. But that meeting occurred before strong data releases on job gains in January, and reports of a pullback in inflation that was much slower than anticipated. That's a trend expected to continue this week with the release on Friday of a report on how the Fed's preferred inflation index fared in January. On Tuesday, data showed U.S. business activity surprisingly rose in February, reaching its highest level in eight months. S&P Global said its flash U.S. Composite PMI Output Index, which tracks the manufacturing and services sectors, increased to 50.2 this month from a final reading of 46.8 in January. The yield on the 30-year Treasury bond was

down 4.1 basis points at

3.936 %. Earlier in the session, the yield rose to 3.987%, the highest since late December.

A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes , seen as an indicator of economic expectations, was still inverted at -75.5 bps, but less so compared to Tuesday. The gap narrowed to -73.10 bps, the steepest the curve had seen since Feb. 3. This curve has been inverted since July last year and typically predicts a recession. The market is also looking to the auction of U.S. five-year notes, following the sale of two-year notes on Tuesday. February 22 Wednesday 10:24AM New York/1524 GMT Price Current Net Yield % Change (bps) Three-month bills 4.71 4.833 0.017 Six-month bills 4.9025 5.0969 -0.013 Two-year note 99-237/256 4.6643 -0.040 Three-year note 98-232/256 4.3955 -0.048 Five-year note 97-60/256 4.1245 -0.049 Seven-year note 96-180/256 4.0496 -0.042 10-year note 96-160/256 3.9117 -0.041 20-year bond 97-36/256 4.0858 -0.046 30-year bond 94-172/256 3.929 -0.047
DOLLAR SWAP SPREADS

Last (bps) Net

Change

(bps)
U.S. 2-year dollar swap 33.25 2.75
spread
U.S. 3-year dollar swap 19.50 0.75
spread
U.S. 5-year dollar swap 6.50 0.75
spread
U.S. 10-year dollar swap 0.25 0.50
spread
U.S. 30-year dollar swap -39.75 1.00
spread

(Reporting by Gertrude Chavez-Dreyfuss; Editing by Andrea Ricci)

Messaging: rm://gertrude.chavez.reuters.com@reuters.net))