* Benchmark 10-year note yields lowest since August
* Short-covering adds to buying
* Fed bought $3.152 bln notes due 2021-2023
By Ellen Freilich
NEW YORK, Oct 17 (Reuters) - U.S. Treasury yields fell to their lowest in over two months onThursday after a deal to end the U.S. debt ceiling conflict inCongress and reopen the government encouraged investors toreinvest cash and on expectations that the Federal Reserve willnot scale back its stimulus in the near term.
The government had been expected to exhaust its $16.7trillion borrowing limit on Thursday, raising fears it would notmeet benefit payments and debt obligations in coming days.
"There was money waiting to be put to work until this debtceiling issue was resolved, so there's some cash moving off thesidelines," said Matthew Duch, portfolio manager at CalvertInvestments in Bethesda, Maryland.
"Also, the impact of the government shutdown and thepossible fogginess of the economic data we'll get for a whilehas convinced more large firms that the Federal Reserve will notreduce its bond purchases until next year," he said. "It becomesharder for the Fed to remove itself from the market."
Benchmark 10-year notes rose 21/32 in price,their yields easing to 2.59 percent, the lowest since August 12,and down from 2.67 percent late on Wednesday. Those yields havedropped from 3.00 percent before the Fed decided last month notto pare its bond purchases.
Short-covering also helped lift bond prices.
"Some people had thought the 10-year yield might rise to 3percent, but with the rally pushing the yield down to 2.60percent, it forced some people out of their short positions,"Duch said.
Data on new jobless claims in the latest week, which showedclaims declining less than economists' estimates, also supportedTreasuries, as a weaker U.S. employment picture would make itless likely the Federal Reserve would scale back on its bondpurchases.
A stronger-than-forecast reading on the Philadelphia FederalReserve's October business activity index briefly causedTreasuries to shave a sliver of their gains, but prices of U.S.government debt soon resumed their upward climb.
The partial government shutdown is seen as having dampedeconomic growth, postponing the point at which the Fed wouldbegin trimming its $85 billion a month in bond purchases.
Most market participants had expected the Fed to announce itwould trim purchases at its September meeting. Now many believethat won't happen until next year. Investors are also bettingthe Fed won't raise interest rates until April 2015.
John Briggs, U.S. rates strategist at RBS Securities inStamford, Connecticut, said the door remained open for "anoversold correction" in Treasuries.
"A rally led by the belly of the curve could take 10-yearyields at least to 2.45 percent and five-year yields to the 1.28percent area in the coming month to six weeks," he said.
On Thursday, five-year note yields stood at 1.33 percent.
Briggs recommended buying the dips in the 2.75 percent to2.80 percent region on the 10-year yield.
A "rock solid" bid for Treasuries emerged overnight withbuyers in Asia and real money and hedge fund buying "of thebelly and intermediates in decent size," said Thomas di Galoma,co-head of fixed income rates at ED&F Man Capital in New York.He also cited "massive buying" from London-based accounts withshort-covering from the dealer and hedge fund community.
With prompt payment on short-term U.S. debt now assured,rates on October U.S. Treasury bills due Nov. 14 lasttraded at 0.02 percent, down 1 basis points from late Wednesday,according to Reuters data.
The overnight general collateral repo rate eased a bit afterthe agreement in Washington, pointing to increased liquidity inthe money markets, but it remained "quite elevated," said JohnCanavan, fixed-income analyst at Stone & McCarthy ResearchAssociates in Princeton, New Jersey.
The U.S. overnight repo rate, at its lowest level in a week, still stood at 0.18 percent, down about 5 basis points,according to Reuters data.
The Fed bought $3.152 billion in notes due between 2021 and2023 on Thursday as part of its plan to stimulate the economyand reduce unemployment. It will buy between $1.25 billion and$1.75 billion in bonds due 2036 to 2043 on Friday.
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