*

Trade tensions and credit market concerns drive Treasury

yields

lower

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US mid-Atlantic manufacturing contracts in October

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US homebuilder sentiment vaults to 6-month high

(Updates to afternoon US trading)

By Chuck Mikolajczak

NEW YORK, Oct 16 (Reuters) - U.S. 10-year Treasury

yields dropped on Thursday, with the yield on the two-year note

hitting its lowest level in over three years, as concerns over

trade tensions between the U.S. and China along with credit

market worries curbed the appetite for riskier assets.

Yields have moved sharply lower since Friday, when U.S.

President Donald Trump threatened to raise tariffs on Chinese

goods to triple digits, followed this week by both countries

charging additional port fees on ocean shipping firms and

criticism by U.S. officials of China's expanded rare earth

export controls.

After holding near the unchanged mark in early trading, yields

tumbled as U.S. stocks sold off, weighed down by declines in

regional banks after Zions Bancorporation said it would

take a charge-off on two commercial and industrial loans,

increasing concerns about the credit market on the heels of

bankruptcies by auto parts maker First Brands and subprime

lender Tricolor.

"The markets are starting to react to the potential that a

more intense trade war could actually hurt not only the world

economy, but certainly our economy," said Ron Albahary, chief

investment officer at LNW in Philadelphia. He said the credit

concerns increased anxiety.

"At this point, what we might be seeing is just a flight to

quality, a traditional flight to quality, which is causing

Treasuries to rally a bit here."

The yield on the benchmark U.S. 10-year Treasury note

declined 6.9 basis points to 3.976% after falling

to 3.971%, its lowest level since April 7.

Federal Reserve Governor Christopher Waller said he would like a

25 basis point interest rate cut at the central bank's October

meeting due to the mixed labor market readings but sees a slower

path of cuts should the job market speed up or GDP holds up

while fellow Governor Stephen Miran again made the case for an

even more aggressive path of cuts.

Markets are fully pricing in a cut of at least 25 basis points

at the Fed meeting later this month, according to CME's FedWatch

Tool, with a 3.2% chance for an outsized 50 basis point

reduction.

The two-year U.S. Treasury yield, which typically

moves in step with interest rate expectations for the Fed,

tumbled 8 basis points to 3.426% after dropping to 3.412%, its

lowest since September 2022.

Investors have also been grappling with a lack of economic data

due to the ongoing government shutdown.

Despite the government shutdown, some economic data was still

being released. The Philadelphia Federal Reserve Bank said its

business activity index dropped to -12.8 this month from 23.2 in

September and below the 8.5 estimate of economists polled by

Reuters. A reading below zero indicates contraction.

In addition, the National Association of Home Builders/Wells

Fargo Housing Market index showed homebuilder sentiment jumped

to a six-month high in October amid hopes that declining

mortgage rates would stimulate demand for housing.

The yield on the 30-year bond fell 5.5 basis

points to 4.583%.

A closely watched part of the U.S. Treasury yield curve

measuring the gap between yields on two- and 10-year Treasury

notes, seen as an indicator of economic

expectations, was at a positive 54.7 basis points.

The breakeven rate on five-year U.S. Treasury

Inflation-Protected Securities (TIPS) was last at

2.317% after closing at 2.351% on Wednesday, its lowest since

June 30.

The 10-year TIPS breakeven rate was last at

2.274%, indicating the market sees inflation averaging about

2.3% a year for the next decade.