TREASURIES-Yields edge higher ahead of labor market data, supply

(Updates for New York afternoon)

By Alden Bentley

NEW YORK, Jan 3 (Reuters) - U.S. Treasury yields held steady near recent highs on Friday, ticking upward after encouraging manufacturing news but marking time in holiday-deadened trade before key employment data and a wave of note and bond issuance next week.

Yields were down slightly before the Institute of Supply Management purchasing managers index surprised to the upside by gaining 0.9 point to 49.3, its highest reading since March, nudging ever closer to the 50 expansion/contraction reading.

Reaction was muted, with many traders stretching out their Christmas and New Year breaks, especially since Manufacturing makes up a far smaller portion of the U.S. economy than the consumption side.

The market will be more focused on the string of labor market data coming out next week, culminating in Friday's December employment report.

"In a quiet market like this without any huge factor in the immediate term, the market just moves to flows and the flows could be for any sort of reason, whether it's an arbitrage or just portfolio flattening," said Lou Brien, market strategist at DRW Trading in Chicago.

Given low unemployment and stubborn inflation, the Federal Reserve is expected to refrain from easing again this month, with traders in Fed funds futures putting the odds of it standing pat near 90% and chances of the first 25 basis-point cut of 2025 coming in March at 50/50.

The Fed reduced interest rates by a full percentage point from September to December, beginning a more accommodative monetary policy after hiking rates from zero to about 5.25% to combat runaway inflation in 2022 and 2023.

A selloff in government debt as the market repriced expectations for Federal Reserve policy in 2025 hoisted the 10-year yield above 4.64% on Dec. 26, its highest level since early May. The two-year yield is not far from its November-December levels above 4.36%, which were last seen in July's rate decline as markets were pricing in the start of Fed easing.

There is also uncertainty over how President-elect Donald Trump's promised tariffs, tax cuts and immigration crackdown might affect the economy and an already enormous fiscal deficit.

Republican Mike Johnson won a close vote on Friday to retain the speakership in the U.S. House of Representatives.

The vote highlighted Republican divisions and the speaker will have a big job taking on Trump's sweeping legislative agenda. Congress must address the nation's debt ceiling later this year with the federal government more than $36 trillion in debt and many congressional Republicans are expected to demand significant spending cuts.

Another reminder of the government's budget challenge comes with next week's Treasury auctions of $119 billion of coupon securities to help fund the excess spending: $58 billion in three-year notes on Tuesday, $39 billion in 10-year notes on Wednesday and $22 billion of 30-year bonds on Thursday.

"The 10s are still the interesting one to watch," Brien said. "I mean, we're higher than we started this easing cycle at and that usually indicates some concern over the Fed's stance versus inflation. But we have stabilized."

The yield on benchmark U.S. 10-year notes rose 1.4 basis points from Thursday's late level to 4.589%. The 30-year bond yield rose 1 basis point to 4.8079%.

The 2-year note yield, which typically moves in step with interest rate expectations for the Federal Reserve, went up 2 basis points to 4.268%.

The 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 at a positive 31.9 basis points, slightly steeper than +31.5 bp late on Thursday.

The implied breakeven inflation rate on 10-year Treasury Inflation Protected Securities (TIPS) rose to 2.3438% from 2.3387 late on Thursday.

The five-year TIPS breakeven inflation rate was at 2.4149% compared with Thursday's 2.4069%, suggesting that investors think annual inflation will average above the Fed's 2% target rate for the next five years. (Reporting by Alden Bentley in New York Editing by Dan Wallis and Matthew Lewis)