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TREASURIES-U.S. Treasury yields plunge as market prices lower inflation

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(Adds two-, five-year notes in largest weekly plunge since March 2020, freshens prices) By Herbert Lash NEW YORK, July 1 (Reuters) - U.S. Treasury yields tumbled on Friday and the benchmark 10-year note fell the most since COVID-19 roiled markets in March 2020, as investors priced in the likelihood the Federal Reserve will force inflation down to near its target rate. The breakeven rate on longer-dated inflation-protected bonds, which measures the difference with the yield on nominal Treasury debt, fell to nine-month lows as investors scrambled to stay abreast of the Fed's aggressive plans to hike interest rates to corral inflation nearing a double-digit annual pace. Yields on two- and five-year notes fell 22 basis points and 24 basis points each this week, their largest weekly drops since March. The yield on 10-year notes tumbled 23.3 basis points from the open to the session's lowest point, before paring the decline, to end down 8.5 basis points at 2.889%. The two-year yield, which typically moves in step with interest rate expectations, slid 8.8 basis points to 2.839%. Both the two-year and 10-year yields were at roughly four-week lows. The breakeven rates on five- and 10-year Treasury Inflation-Protected Securities, or TIPS, slid to 2.636% and 2.362%, respectively, a level last seen in September 2021. "The breakeven market, the difference between TIPS versus regular Treasuries, is dramatically downward sloping. It's barely above the Fed's long-term average (inflation) target of 2%," said Nancy Davis, managing partner and chief investment officer at Quadratic Capital Management LLC in Greenwich, Connecticut. "The market is pricing that the Fed's hiking rates is going to dramatically bring down future CPI inflation," she said. Uncertainty about when inflation will peak and how deep and long a potential recession might be is upending all security markets, whether credit or equities, said Dec Mullarkey, managing director of investment strategy and asset allocation at SLC Management in Boston. "Central banks are saying the biggest threat out there is inflation and we're going do whatever it takes to get that under control," Mullarkey said. "That's the message that the markets have priced into their securities. They're saying, 'There's a lot of risk, there's a lot of volatility.'" The S&P 500 this week posted its steepest first-half decline since 1970 on fears of inflation and inflation's impact on growth. U.S. manufacturing activity slowed more than expected in June, with a measure of new orders contracting for the first time in two years, signs the Fed's policy tightening is cooling the economy. The gap between yields on two- and 10-year Treasury notes , seen as an indicator of a potential recession when the short end of the yield curve inverts and rises above the long end, was at 4.5 basis points. The U.S. dollar 5 years forward inflation-linked swap , seen by some as a better gauge of inflation expectations due to possible distortions caused by the Fed's quantitative easing, was last at 2.349%. July 1 Friday 2:40 PM New York / 1840 GMT Price Current Net Yield % Change (bps) Three-month bills 1.6725 1.7025 0.002 Six-month bills 2.4525 2.5169 0.012 Two-year note 100-79/256 2.839 -0.088 Three-year note 100-8/256 2.8635 -0.116 Five-year note 101-176/256 2.8842 -0.120 Seven-year note 102-2/256 2.9301 -0.100 10-year note 99-224/256 2.8894 -0.085 20-year bond 98-80/256 3.367 -0.012 30-year bond 95-88/256 3.1156 -0.006 DOLLAR SWAP SPREADS Last (bps) Net Change (bps) U.S. 2-year dollar swap 311.25 280.25 spread U.S. 3-year dollar swap 295.25 282.75 spread U.S. 5-year dollar swap 2.75 -0.25 spread U.S. 10-year dollar swap 7.00 -0.25 spread U.S. 30-year dollar swap -24.25 -0.75 spread (Reporting by Herbert Lash; additional reporting by Gertrude Chavez-Dreyfuss in New York; Editing by Marguerita Choy and Leslie Adler)