(Updated at 0920 EDT)

By Karen Brettell

NEW YORK, Aug 5 (Reuters) - U.S. Treasury yields dropped

to more than one-year lows on Monday and a closely watched part

of the Treasury yield curve turned positive for the first time

in two years on increasing concerns that the United States may

be heading into a recession.

An unexpected increase in the employment rate and fewer than

expected jobs gains in July's employment report on Friday

sparked a rapid repricing of expectations on when and how far

the Federal Reserve will cut interest rates.

The U.S. central bank is now seen as possibly cutting

interest rates before its next scheduled meeting in September,

or making a larger cut then to stave off a severe economic

downturn.

"There is more convincing evidence that there could be more

potentially negative ramifications from the Fed being as

restrictive as it was for as long as it has been," said Ian

Lyngen, head of U.S. rates strategy at BMO Capital Markets in

New York.

"Conversations about an inter-meeting rate cut have picked

up," Lyngen added, but "we don't think the Fed's going to cut

inter-meeting. I think the biggest debate is whether or not they

go 25 or 50 (basis points) in September."

Traders are now fully pricing in a cut of at least 50 basis

points in September, according to the CME Group's FedWatch Tool.

That was seen as only having 11% odds a week ago. In total, 131

basis points of easing is priced in by year-end.

Chicago Federal Reserve Bank President Austan Goolsbee on

Monday said while the U.S. employment data on Friday was weaker

than expected, it does not look like a recession, but that Fed

officials need to be cognizant of changes in the environment to

avoid being too restrictive with interest rates.

Tumbling stock markets globally and concerns about

increasing geopolitical tensions in the Middle East added to

demand for the safe haven U.S. government debt.

Yields on interest rate sensitive two-year notes

were last down 14.2 basis points at 3.73% and got as low as

3.654%, the lowest since April 2023.

Benchmark 10-year note yields dropped 11.2 basis points to

3.684% and reached 3.667%, the lowest since June 2023.

The gap between two- and 10-year Treasury notes

was last at minus 4.6 basis points, after earlier

reaching 1.50 basis points. It is the first time it has turned

positive since July 2022.

An inversion in the yield curve typically indicates that a

recession is likely in the next one-to-two years, though this

inversion has lasted longer than in previous episodes.

The curve usually turns positive before a downturn begins.