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Investors seek safe assets amid U.S. government shutdown

risk

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Shutdown could impact economic growth, Fed's labor market

data

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Previous shutdowns saw S&P 500 gains, lower Treasury

yields

(Updates prices; adds quotes from market participants, context)

By Davide Barbuscia

NEW YORK, Sept 30 (Reuters) - U.S. Treasury yields were

mixed on Tuesday as the prospect of an imminent U.S. government

shutdown gained ground, with some investors seeking safe assets

amid political uncertainty.

Federal agencies are preparing to send thousands of workers

home, as Republicans and Democrats appeared unlikely to reach an

agreement that would extend funding past a midnight deadline on

Tuesday. The Labor Department meanwhile has said that if there

is a shutdown it would not issue its monthly unemployment

report, due on Friday, which investors and the Federal Reserve

scrutinize as a key barometer of economic health.

The risk of a protracted shutdown could have an impact on

economic growth in the fourth quarter, analysts have said, and

leave the U.S. central bank without a crucial gauge of the labor

market at a time when mounting concerns over weakening jobs

growth have strengthened market expectations of multiple

interest rate cuts.

"The fact that we're not going to get potentially

significant labor data for some time leads to a bit of a flight

to quality from a Treasury standpoint," said Brendan Murphy,

head of fixed income, North America, at Insight Investment.

"To me, it's more about the absence of data as opposed to

any sort of big negative macro impact from the shutdown," he

added.

Historically, government shutdowns haven't hurt major

financial assets. In fact, during the last six shutdowns the S&P

500 stocks index gained ground each time, with the most recent

one in 2018-2019 coinciding with a sharp 10% rally, Deutsche

Bank said in a note. Similarly for Treasuries, 10-year yields

ended lower in each of the last five shutdowns, the bank said.

Yields move inversely to bond prices.

The Fed lowered interest rates earlier this month and

policymakers have anticipated another rate cut at the central

bank's next rate-setting meeting at the end of October. Should

official labor market data continue to be unavailable until then

because of the shutdown, the central bank could be forced to

rely more heavily on its own forecasts, making another 25 basis

point rate cut in October more likely, analysts said.

"If a government shutdown removes the potential for the data

to prevent further normalization, it follows intuitively that

the Fed will offer another 'risk management' cut," BMO Capital

Markets analysts said in a note. "After all, there are plenty of

risks to the real economy by sending home a significant portion

of the federal labor force," they said.

On the data front on Tuesday, the Bureau of Labor Statistics

reported that the number of job openings in August was roughly

unchanged month on month, while the Chicago Purchasing Managers'

Index (PMI), a gauge of regional manufacturing activity, fell to

40.6, missing forecasts.

U.S. consumer confidence declined more than expected in

September amid mounting worries over the availability of jobs,

the Conference Board said on Tuesday.

Rates futures traders late on Tuesday were assigning a 97%

probability of a 25 basis point rate cut in October, up from 90%

on Monday.

Federal Reserve Bank of Boston President Susan Collins said on

Tuesday that she's open to more interest rate cuts amid

expectations price pressures will start to wane sometime next

year.

Benchmark 10-year Treasury yields had declined

earlier on Tuesday but the notes pared back those gains later in

the day, with yields closing flat at 4.146%.

There was no macroeconomic driver behind the reversal, said

Subadra Rajappa, head of U.S. rates strategy at Societe

Generale, citing some block-selling that pushed yields higher.

Two-year yields, which tend to more closely

reflect market expectations of interest rate changes, were about

three bps lower at 3.6%.

The 10-year yield has decreased by eight basis points in

September and by about the same amount in the third quarter.

Two-year yields have gone down by two basis points in September,

but declined by about 12 bps over the past three months.

The closely-watched yield curve comparing two- and 10-year

yields has flattened over the past month, but it

has steepened by about four bps in the third quarter. The

steepening - which happens when the yield premium of long-dated

debt over shorter-dated debt increases - coincided with rising

expectations of interest rate cuts over the next few months.

Tom di Galoma, managing director of rates and trading at

Mischler, said on Tuesday he expects that dynamic to accelerate

next week when the Treasury will sell three-year, 10-year, and

30-year debt.

"We get supply next week, that's why I think the curve

should steepen," he said.