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Two-year yields heading for largest monthly drop in a year

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PCE data matches economists expectations for July

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Position squaring, month end push yields higher on Friday

By Karen Brettell

Aug 29 (Reuters) - U.S. Treasury yields rose on Friday

though interest rate sensitive two-year yields were on track for

their largest monthly drop in a year as traders squared

positions ahead of Monday's Labor Day holiday and with inflation

data for August meeting economists' expectations.

The Personal Consumption Expenditures (PCE) Price Index

increased 0.2% last month after an unrevised 0.3% rise in June,

data on Friday showed. Excluding the volatile food and energy

components, the PCE Price Index increased 0.3% last month,

matching the rise in June.

The data keeps the Federal Reserve on track to cut rates at

its September 16-17 meeting, as is widely expected.

"You can check this off as one more risk to potentially

derailing a cut in September. The inflation part of it, at least

in this measure, is not going to do anything to reduce odds of a

cut in September," said Michael Lorizio, head of U.S. rates

trading at Manulife Investment Management in Boston.

Fed funds futures traders are now pricing in 89% odds of a

cut next month, up from 84% before the data.

Traders ramped up bets on more cuts after Fed Chair Jerome

Powell last Friday adopted an unexpectedly dovish tone and said

that risks to the job market were rising.

Efforts by U.S. President Donald Trump to fire Fed Governor

Lisa Cook also raised the prospect that Trump could make more

dovish appointments to the U.S. central bank that then result in

easier policy.

A federal judge on Friday will consider whether to block

Trump temporarily from firing Cook while she pursues a lawsuit

claiming Trump has no valid reason to remove her.

Still, yields edged higher on Friday as traders closed

positions ahead of the long weekend and repositioned for month

end.

Some interest rate hedging was also likely influencing the

market with corporate debt markets expected to pick up next week

when many people return from summer vacations.

"We have a very busy week coming up next week with primary

markets and all the spread product markets returning in full

force, especially the corporate bond market," said Lorizio.

Jobs data for August is also due next Friday, which may be

key in determining near-term Fed policy.

The 2-year note yield was last up 0.2 basis

points on the day at 3.637%. It has fallen 32 basis points this

month, the most since last August.

The yield on benchmark U.S. 10-year notes rose

2.3 basis points to 4.23%.

The yield curve between two-year and 10-year notes

was last at 57 basis points. It has steepened by

16 basis points this month, the most since April.