TREASURIES-US yields fall on big private payrolls miss; Fed rate cut bets affirmed

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Market to continue to focus on labor market weakness

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US services sector index flat; jobs index still in contraction

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US 2/10 yield curve little changed, but still in steepening bias

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US rate futures price in 91 bps of rate cuts next year.

(Adds new comment, updates yields)

By Gertrude Chavez-Dreyfuss

NEW YORK, Dec 3 (Reuters) - U.S. Treasury yields retreated on Wednesday after data showed a surprise decrease in private-sector payrolls in November, adding to worries about labor market weakness and cementing expectations of a rate cut by the Federal Reserve next week.

In afternoon trading, the benchmark 10-year yield fell 2.9 basis points (bps) to 4.059%, while the 30-year yield dipped 1.6 bps to 4.725%.

On the front end of the curve, the two-year yield, which reflects interest rate moves by the Fed, was down 3 bps at 3.486%.

Data showed that U.S. private employment decreased by 32,000 jobs last month after an upwardly revised 47,000 increase in October. Economists polled by Reuters had forecast private employment rising by 10,000 after a previously reported 42,000 rebound in October.

Following the data, U.S. rate futures have priced in an 89% chance of a 25-bp cut next week, up from 83.4% a week ago, CME FedWatch showed.

"The labor market is going to be the driver of Fed policy right now because if we're looking at what the risks are, the risk of inflation accelerating from here seems pretty low to us and most economists, and for the Fed, the risk of the labor market deteriorating more than expected is going to be the focus," said Collin Martin, head of fixed income research and strategy at the Schwab Center for Financial Research in New York.

"So when we get any sort of negative reading on the labor market, like we got ... with the ADP report, expectations about the path of Fed policy are going to shift. If it seems like the labor market is going to pivot from just gradually cooling to actually deteriorating sharply, that would imply a greater number of cuts over the next 12 months or so."

US SERVICES SECTOR RETURNING TO TREND GROWTH?

Separately, the U.S. services sector activity held steady in November, with employment still subdued and prices for inputs elevated, a survey showed on Wednesday. The report did not dent expectations of Fed easing next week.

The Institute for Supply Management said its non-manufacturing purchasing managers index was little changed at 52.6 last month from 52.4 in October, but it was still the highest since February, analysts said. Economists polled by Reuters had forecast the services PMI slipping to 52.1.

Tom Simons, chief U.S. economist, at Jefferies in New York wrote in a research note that the ISM services index has averaged 51.3, which indicated a "gradual return to trend growth."

He added that business planning was characterized as "impossible" after the tariff announcements in early April, "but trade policy has been far less volatile since then."

"Tariffs are causing headaches in many industries, and pressuring prices for both goods and services, but the data suggest that this pressure has probably peaked," Simons said.

In other parts of the bond market, the yield curve, which reflects monetary policy expectations, was last little changed, with the spread between U.S. two-year and 10-year yields at 57 bps, from 57.4 bps on Tuesday. The curve steepened to as high 58.3 bps earlier in the session, and hit 59 bps on Tuesday, the widest spread since September.

The curve exhibited a moderate bull-steepening pattern, a scenario in which shorter-dated yields are falling faster than those on long maturities. It's mostly a reflection of market expectations that the Fed will cut interest rates imminently.

Fed funds futures have factored in 91 bps of easing next year, with two rate declines in the first half amid expectations that the new Fed chair will be advocate for more rate cuts in line with what President Donald Trump wants.

White House economic adviser Kevin Hassett, a known dove, is said to be the frontrunner to replace Jerome Powell as the head of the Fed. (Reporting by Gertrude Chavez-Dreyfuss; Editing by Tomasz Janowski, Chizu Nomiyama and Deepa Babington)