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* U.S. economy grew by 4.1 pct in second quarter
* Yield curve flattens as inflation disappoints
By Karen Brettell
NEW YORK, July 27 (Reuters) - U.S. Treasury yields retreated from six-week highs on Friday after data showed the U.S. economy grew at its fastest pace in nearly four years, but came in below high expectations for the number.
Gross domestic product increased at a 4.1 percent annualized rate also as government spending picked up, the Commerce Department said in its snapshot of second-quarter GDP on Friday.
Economists had expected the economy would grow by 4.2 percent, according to a Bloomberg survey.
“The headline number was a little bit below consensus and perhaps a little below what the market was pricing in,” said Jonathan Cohn, an interest rate strategist at Credit Suisse in New York.
The yield curve also flattened as the report showed benign inflation.
The Fed’s preferred inflation gauge, the personal consumption expenditures (PCE) price index excluding food and energy, increased at a 2.0 percent rate in the second quarter after rising at a 2.2 percent pace in the January-March period.
“You had strong growth numbers but inflation did disappoint on the weak side. ... I’d say that’s one of the key drivers behind the flattening,” said Cohn.
Benchmark 10-year notes gained 4/32 in price to yield 2.962 percent, down from a high of 2.988 percent reached in overnight trading, which was the highest since June 13.
The yield curve between 2-year and 10-year notes flattened to 28 basis points, from 30 basis points before the data.
Investors are next focused on the Bank of Japan’s meeting next week for any signs of how or when it may alter its massive stimulus.
Yields have risen and the yield curve has steepened since a Reuters report on July 20 that the Japanese central bank is in unusually active discussions before this month’s policy decision, with changes to its interest-rate targets and stock-buying techniques on the table.
If this is not evident in the meeting statement on Tuesday, the yield curve may flatten again.
“We don’t expect any such discussion yet. We’re looking for a lot of that to get unwound and for the curve to keep flattening,” said Gennadiy Goldberg, an interest rate strategist at TD Securities in New York.
The curve has steepened from 23 basis points last week, which was the flattest level in a decade. (Reporting by Karen Brettell; editing by Jonathan Oatis and Nick Zieminski) )