TREASURIES-10-year yields fall to 15-month low, size of Fed rate cut in question

(Updated at 1430 EDT)

By Karen Brettell

NEW YORK, Sept 6 (Reuters) - Benchmark 10-year Treasury yields fell to a 15-month low on Friday before paring back in choppy trading as August's payrolls report failed to offer a clear signal on the size of an expected Federal Reserve interest rate cut later this month.

Nonfarm payrolls increased by 142,000 jobs last month after a downwardly revised 89,000 rise in July. Economists polled by Reuters had forecast payrolls increasing by 160,000 jobs.

The unemployment rate fell to 4.2%, from 4.3% the prior month.

"The market's really struggling with this one because it's really in the middle of what could be used as a justification for either a 25 or 50 basis point rate cut," said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities in New York.

U.S. 10-year Treasury yields were last down 2.5 basis points at 3.708% and earlier fell as low as 3.648%, the lowest since June 2023.

Interest rate-sensitive two-year yields fell 10.6 basis points to 3.646% and reached 3.595%, the lowest since March 2023.

The closely watched yield curve between two- and 10-year notes was at 6 basis points, the steepest since July 2022.

The bond market is pricing in an aggressive path of rate cuts over the coming year and a half, even as many economists see the U.S. avoiding a recession.

Fed funds futures traders are now pricing a 73% chance of a 25 basis point cut at the Fed's Sept. 17-18 meeting, and a 27% chance of a 50 basis point reduction, according to the CME Group's FedWatch Tool.

In total 251 basis points of cuts are priced in by the end of 2025.

""The payroll report suggests there is no reason for the Federal Reserve to rush," said Drew Matus, chief market strategist at MetLife Investment Management in New Jersey. "The labor market is slowing, but at a slow pace, allowing the Fed to move more deliberately in September."

Some of the underlying details of Friday's report, including downward revisions of 86,000 jobs gains for the past two months, however, may be a warning that the labor market is not as healthy as hoped.

"We do see the labor market really not just coming into balance, but really starting to cool off quite significantly, which could make the Fed quite nervous," said TD's Goldberg.

Fed policymakers on Friday said they are ready to lower interest rates at the U.S. central bank's meeting in two weeks, with one of them saying he could support back-to-back reductions, or a bigger cut in borrowing costs, should the cooling labor market need support.

The Treasury next week will sell $119 billion in coupon-bearing supply, including $58 billion in three-year notes on Tuesday, $39 billion in 10-year notes on Wednesday and $22 billion in 30-year bonds.

(Reporting By Karen Brettell; Additional reporting by Sin?ad Carew; Editing by Christina Fincher, Alex Richardson, Jonathan Oatis and Deepa Babington)