TREASURIES-U.S. yields sink ahead of Fed; investors wary of stock sell-off

* U.S. yield curve flattens * U.S. yields fall to three-week lows * Bonds look to small sector of stock market * Fed policy announcement due, but little fireworks seen (Adds new comment, updates prices) By Gertrude Chavez-Dreyfuss NEW YORK, Jan 27 (Reuters) - U.S. Treasury yields slumped on Wednesday, in line with weaker stocks, as risk appetite hit a wall ahead of the Federal Reserve's policy announcement as global economic worries grew amid surging virus cases and challenges to vaccine rollouts. The Fed announcement though is not expected to shake the market, as the U.S. central bank is likely to keep its ultra-accommodative policy as the economy battles the pandemic, analysts said. But investors would want to see the Fed's economic outlook given the new administration in Washington and the possibility of strong fiscal measures. "The Fed is not going to signal anything hawkish. I think they're gun-shy," said Ellis Phifer, market strategist, at Raymond James in Memphis, Tennessee. Bond investors are also looking at the stock market, in which small companies with the largest bearish bets against them have risen 60% on average so far this year, easily outperforming the rest of the market. Shares of GameStop and AMC Entertainment Holdings each more than doubled on Wednesday, forcing hedge funds to take heavy losses as they unloaded short positions. "People are looking at bonds as a safe haven. It all harkens back to the short-seller market and the short-covering rally," Phifer said. "It just becomes potentially endemic and it's like a virus. If it continues to spread, you get more margin calls, more firms having to potentially shut down and they're leveraged so they start selling more and you can end up in a bad spot." Yields across the curve moved in tandem, dropping to three-week lows. That flattened the yield curve, an indicator of risk appetite, with the spread between two-year and 10-year notes hitting 88.40 basis points, the narrowest gap in three weeks. "There are concerns about the labor market as U.S. payrolls are coming up soon," said Stan Shipley, fixed income strategist, at Evercore ISI in New York. "There are concerns about what's going on in Europe. Their economies are suffering again and the odds are rising that they may have a double-dip recession. In midday trading, the U.S. benchmark 10-year yield fell to 1.009%, from 1.04% late on Tuesday. It earlier fell to 1.001%, its lowest since Jan. 6. U.S. 30-year yields dropped to 1.774% from Tuesday's 1.802%, after earlier sliding to a three-week low of 1.761%. At the front end of the curve, U.S. two-year yields were down at 0.117%, hitting a three-week low of 0.115% earlier in the session. The break-even inflation rate on 10-year TIPS, meanwhile, which measures expected annual inflation over the next decade, dropped below 2% for the first time since late December. It was last at 1.987%, down from Tuesday's 2.004%. Analysts have been touting for weeks that breakeven rates are stretched in terms of valuation and are due for a pullback. January 27 Wednesday 12:10 PM New York / 1710 GMT Price Current Net Yield % Change (bps) Three-month bills 0.075 0.0761 -0.003 Six-month bills 0.08 0.0811 -0.003 Two-year note 100-4/256 0.1172 -0.008 Three-year note 99-220/256 0.1726 -0.010 Five-year note 99-218/256 0.405 -0.022 Seven-year note 99-120/256 0.7037 -0.023 10-year note 98-188/256 1.011 -0.029 20-year bond 96-140/256 1.5788 -0.028 30-year bond 96-136/256 1.7754 -0.027 DOLLAR SWAP SPREADS Last (bps) Net Change (bps) U.S. 2-year dollar swap 7.50 0.25 spread U.S. 3-year dollar swap 8.25 0.50 spread U.S. 5-year dollar swap 9.00 -0.75 spread U.S. 10-year dollar swap 3.50 0.25 spread U.S. 30-year dollar swap -25.25 -0.50 spread (Reporting by Gertrude Chavez-Dreyfuss; Editing by Kirsten Donovan)