TREASURIES-US yields falter as rate cut potential weighs

By Gertrude Chavez-Dreyfuss

NEW YORK, Aug 20 (Reuters) - U.S. Treasury yields slipped on Tuesday as an interest rate cut next month loomed large heading into Federal Reserve Chair Jerome Powell's remarks on Friday at a central bank gathering in Jackson Hole, Wyoming.

The federal funds futures market has fully priced in easing by the Fed at the September meeting, with a 74% chance of a 25 basis-point cut. Traders have also priced in about 97 bps of cuts by the end of the year, down from about 150 bps a few weeks ago at the height of the panic earlier this month driven by the soft U.S. nonfarm payrolls report for July and the sudden unwinding of the yen carry trade.

In a carry trade, an investor borrows in a currency with low interest rates like the yen and invests the proceeds in higher-yielding assets.

Since that turbulent period, the U.S. numbers have depicted an economy that is unlikely to tip into a recession anytime soon, even as the Bank of Japan has moved to calm investor nerves.

In late morning trading, the benchmark 10-year yield dipped 3.8 bps to 3.83%. So far this month, it has dropped 27 bps, on track for its biggest monthly decline since December.

"What is driving yields lower has been the weaker economic landscape, combined with current policy rates being as elevated as they are. It's not as if people are forecasting recession," said Jim Barnes, director of fixed income at Bryn Mawr Trust in Berwyn, Pennsylvania.

"It is more about investors trying to reconcile where the economy is today and where policy rates should be. In that context, yields are kind of forcing the Fed at this point to reconsider adjustments going forward."

U.S. 30-year yields fell to a two-week low of 4.085% , and were last down 2.5 bps at 4.09%.

On the front end of the curve, the two-year yield, which reflects interest rate moves by the Fed, fell 6.1 bps to 4.006% .

The closely watched U.S. two-year/10-year yield curve narrowed its inversion, or steepened, to minus 18 bps .

The curve bull-steepened on Tuesday, which means that short-dated rates fell more sharply than longer-dated ones. Yield curves historically steepen ahead of a Fed easing cycle, as investors price in the expectation that rates on the front end have and the Fed's next move would be a rate cut.

A steeper curve shows longer-dated yields are higher than those on shorter maturities, reflecting a normal upward slope. This means investors are being compensated more for the risk of holding longer-term securities.

Investors remained focused on the Jackson Hole meeting starting Friday, in which Chair Powell is scheduled to speak.

"We anticipate a generally dovish speech, with the Chair teeing up a rate cut at the next FOMC meeting on September 18," John Velis, macro strategist at BNY Mellon, wrote in a research note.

"However, we don't expect the speech to be heavy on specifics and it's unlikely that key questions about the size of the first rate cut, or the frequency or length of the cutting cycle will be answered." (Reporting by Gertrude Chavez-Dreyfuss; editing by Jonathan Oatis)