TREASURIES-U.S. rates markets will focus on ECB decision

* Treasury investors will closely watch ECB rate decision

* Yield curve flattening suggests more rate hike risk

* Two-year note yields test 10-month highs

* US repo rates turn negative
(Adds details on repos)

By Karen Brettell

NEW YORK, April 1 (Reuters) – Investors in U.S. Treasuries
will be closely watching a European interest rate decision next
week as well as looking for further signs of how soon the U.S.
central bank may follow in raising rates.

After an early sell off on Friday, in the wake of good U.S.
employment data, Treasuries ended mostly higher in price,
indicating the market may pause from a two-week selloff fueled
in part by concerns the Fed may raise rates sooner than
previously expected.

The European Central Bank is expected to raise interest
rates when it meets next Thursday, in what would be its first
hike since October 2008.

The U.S. central bank, by contrast, is not expected to hike
rates until next year. Hawkish comments from some Fed members
nonetheless hurt the market this week.

Two-year Treasuries, which are seen as among the most
vulnerable to interest rate risk, have underperformed
longer-dated debt including 10-year notes.

“We’ve shifted into a bullish flattening and bearish
flattening” pattern, said Richard Gilhooly, interest rate
strategist at TD Securities in New York.

“To me that’s telling you that the market is pricing in a
greater probability of Fed tightening,” he added.

The gap between two-year and 10-year note yields has fallen
to around 264 basis points from 283 basis points on March 8.

Two-year notes (US2YT=RR: Quote, Profile, Research) earlier on Friday also tested
support at yields of around 0.89 percent, their highest levels
since last May. The notes last traded at yields of 0.81
percent.

The overnight cost for dealers to obtain cash using U.S.
Treasuries as collateral, meanwhile turned negative on Friday.

Some traders attributed the negative rates in repurchase
agreements to a move by the Federal Deposit Insurance Corp to
charge member banks insurance fees on deposits held by the
Federal Reserve, which went into affect on Friday.

“We think today’s move lower in repo is extreme and
unsustainable,” Barclays analyst Joseph Abate said in a
report.

TREASURIES MAY SEE NEAR TERM SUPPORT

Treasuries may be supported next week by an absence of any
supply auctions, the Fed’s continuing bond purchases and few
significant data releases.

The debt also got a boost on Friday by New York Fed
President William Dudley’s warnings against being overly
optimistic about the growth outlook. See [ID:nN01154414]

The Fed is “looking at the impact of higher oil prices on
overall economic growth as well as, in the near-term, some of
the dislocations and disruptions in economic activity due to
the problems in Japan,” said Michael J. Materasso, senior
portfolio manager and co-head of the fixed-income policy
committee at Franklin Templeton.

The U.S. government on Friday reported the jobless rate
fell to a two-year low of 8.8 percent in March, though it
remains higher than many Fed members are comfortable with.
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
To see a graph on U.S. unemployment, go to
http://r.reuters.com/mab88r
To see payroll numbers relative to 10-year Treasuries,
http://r.reuters.com/dub88r
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Treasuries may be vulnerable to further losses over time,
however, if the economy remains on track and as the Fed ends
its $600 billion bond purchase program in June.

A key factor to watch in June will be whether the Fed
continues to invest funds from maturing mortgage-backed
securities into Treasuries, said TD’s Gilhooly.

“When the Fed starts rolling off MBS they are tightening
policy,” he said.

Five-year notes (US5YT=RR: Quote, Profile, Research) rose 5/32 in price on Friday to
yield 2.25 percent, down from 2.27 percent on Thursday, and
10-year notes (US10YT=RR: Quote, Profile, Research) rose 6/32 in price to yield 3.45
percent, down from 3.47 percent.

Thirty-year bonds (US30YT=RR: Quote, Profile, Research) rose 11/32 in price to yield
4.49 percent, down from 4.51 percent.
(Additional reporting by Ellen Freilich)

TREASURIES-U.S. rates markets will focus on ECB decision