TREASURIES-30Y bond gyrates on QE2 bets; TIPS look tippy

* Long bond rises on short-covering after early losses

* 10Y/30Y spread volatile on changing bets on QE2 size

* Other maturities weaker before $109 bln in coupon supply

* Prospects on 5Y TIPS auction cloudy amid negative yields

(Recasts, update throughout, adds quotes)

By Richard Leong

NEW YORK, Oct 22 (BestGrowthStock) – The U.S. 30-year Treasury bond
rose on Friday as its yield spreads versus other maturities
remained volatile on uncertainties over the size of another
round of policy stimulus from the Federal Reserve.

Other maturities were steady to modestly lower as traders
reduced their holdings ahead of next week’s $109 billion of
coupon-bearing supply including a $10 billion sale of five-year
Treasury Inflation-Protected Securities on Monday.

Traders widely anticipate the U.S. central bank will engage
in a second round of quantitative easing, dubbed “QE2.” Many
expect it will target government debt in the five-to-10-year
range, whose yields are linked to mortgage rates and benchmarks
for investment managers.

A buying focus on intermediate Treasuries, if it were to
occur after the Fed’s Nov 2-3 policy meeting, could leave the
30-year bond out in cold, analysts said.

So as the specter of QE2 looms larger, the gap between
30-year and 10-year yields has turned choppier on wavering
expectations how aggressively the Fed will pursue its goal of
lower long-term borrowing costs.

“That’s a great proxy for the market expectations on the
size of QE2,” said David Gottlieb, principal at EMF Financial
Products in New York of the 10-to-30-year yield spread. “Is the
market pricing in a ‘shock-and-awe’ or a more limited, open
option? That’s what the market is trying to get its arms
around.”

The 30-year-10-year spread was last at 137 basis points on
Friday, the tightest in 1-1/2 weeks, as traders who have
shorted 30-year bonds bought them back after they failed to
push their yields higher in early trading.

The 30-year bond yield (US30YT=RR: ) last traded at 3.94
percent, down from 3.96 percent late Thursday. Earlier, it
flirted with chart support at 4.00 percent for the third time
in the the past six sessions.

The 10-year yield (US10YT=RR: ) notched up to 2.57 percent,
near the high end of its trading range since the QE2-driven
rally that began in August.

GRADUALIST VIEW WINNING OUT

QE2, after the first round involved a combined $1.7
trillion purchase of Treasury and mortgage securities, is aimed
to stimulate borrowing and investments, which has been sluggish
since the worst U.S. recession in 70 years ended a year ago.

In recent days, a number of Fed officials have expressed
their support for an open-ended, gradual approach to QE2, not a
“shock and awe” one that bond bulls have been hoping for.

St. Louis Fed President James Bullard said on Thursday he
would back Fed purchases of Treasuries in $100 billion
increments meeting-by-meeting if the Fed decides monetary
easing is necessary, but stressed no decision has been made.

Shortly after Fed Chairman Ben Bernanke hinted at a
possibility of QE2 in late August, there were far-flung calls
that the Fed could buy up to $1.5 trillion in Treasuries.

Bullard and other Fed officials have reined in expectations
of massive bond purchases.

“More seem comfortable with an incremental approach rather
than ‘shock and awe,'” said Michael Pond, Treasury strategist
with Barclays Capital in New York.

NEGATIVE REAL YIELDS

Amid the QE2 backdrop, traders will contend with next
week’s supply which will kick off with the five-year TIPS
sale.

It is unclear whether bidders will show up for a bond whose
real yield has been stuck in negative territory since September
due to anxiety over deflation, investors said.

Last week, five-year TIPS traded at a record low yield of
minus 0.56 percent.

The Treasury Department adjusts TIPS principal and interest
payments to inflation.

Bets that QE2 will avert deflation have improved the
returns on TIPS over regular Treasuries, as the yield spread or
“breakevens” between five-year TIPS (US5YTIP=TWEB: ) and regular
five-year Treasuries (US5YT=RR: ) grew to 1.66 percentage points
last week from 1.21 points in late August.

The wider breakevens could spur demand at Monday’s auction.
“We expect investors will be enticed more by the breakevens
than real yields,” Barclays’ Pond said.

(Reporting by Richard Leong; Editing by Andrew Hay)

TREASURIES-30Y bond gyrates on QE2 bets; TIPS look tippy