TREASURIES-Yields fall further on moderate inflation outlook, strong economy

(Adds comment, fresh prices) By Herbert Lash NEW YORK, Dec 1 (Reuters) - Moderating inflation in October pushed U.S. Treasury yields down further on Thursday after a strong rally the day before when Federal Reserve Chairman Jerome Powell said the U.S. central bank could slow its pace of interest rate hikes in two weeks. The market embraced new signs of slowing inflation in a strong economy, suggesting the Fed's tightening of monetary policy might induce nothing more than a mild recession. Consumer spending increased at its greatest pace since January and the labor market remained resilient, with the number of Americans filing new claims for unemployment benefits declining last week, signs of a strong U.S. economy. The personal consumption expenditures (PCE) price index showed inflation moderated, as it rose 0.3% in October, the same as in September, and over the 12 months through October the index increased 6.0% after advancing 6.3% the prior month. Excluding the volatile food and energy components, the PCE price index rose 0.2%, one-tenth less than expected, after gaining 0.5% in September. Yields backed off early declines after poor manufacturing data but later slid lower. The benchmark 10-year Treasury slid to 10-week lows and the two-year note, which often indicates interest rate expectations, fell to early October lows. "What the market is looking at is a mosaic of different indicators that suggest the inflation rate is falling from a very high level," said Peter Duffy, chief investment officer of credit at Penn Capital Management Co LLC in Philadelphia. "The bond market wants to see the economy cooling," Duffy added. "Demand for bonds increases when the economy cools so this is probably a big recipe for people wanting to buy bonds yet are concerned about the economy and they think the Fed is slowing down. It's a win-win." The two-year Treasury yield fell 11.4 basis points to 4.258%, while the yield on 10-year notes slid 16.2 basis points to 3.539%. The yield curve measuring the gap between yields on two- and 10-year Treasury notes remained inverted and was at -72.0 basis points. The inversion, when yields on short-dated debt are higher than longer-dated debt, indicates a looming recession. "The yield curve is way too inverted," said Nancy Davis, portfolio manager of the Quadratic interest rate volatility and the IVOL inflation hedge exchange-traded fund. "The market believes the Fed is going to continue to hike but they believe the Fed is going to create a recession, which is consensus at this point," Davis said. Fed funds futures showed the Fed's target rate for lending will peak in May at 4.866%, down from just over 5% earlier in the week. Futures show a 91% chance of a 50-basis-point hike at the Fed's policy meeting Dec. 13-14. . The yield on the 30-year Treasury bond was down 17.1 basis points to 3.652%. The break-even rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) was last at 2.495. The 10-year TIPS breakeven rate was last at 2.363%, indicating the market sees inflation averaging about 2.35% a year for the next decade. The U.S. dollar five 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 2.516%. Dec. 1 Thursday 1:39 p.m. New York / 1939 GMT Price Current Net Yield % Change (bps) Three-month bills 4.21 4.3139 -0.050 Six-month bills 4.495 4.6628 -0.048 Two-year note 100-117/256 4.2584 -0.114 Three-year note 101-96/256 4.001 -0.133 Five-year note 100-216/256 3.6884 -0.140 Seven-year note 101-132/256 3.6277 -0.145 10-year note 104-224/256 3.5394 -0.162 20-year bond 102-20/256 3.8497 -0.160 30-year bond 106-80/256 3.6516 -0.171 DOLLAR SWAP SPREADS Last (bps) Net Change (bps) U.S. 2-year dollar swap spread 33.00 1.50 U.S. 3-year dollar swap spread 13.00 1.00 U.S. 5-year dollar swap spread 3.75 0.25 U.S. 10-year dollar swap spread -4.00 0.25 U.S. 30-year dollar swap spread -42.50 2.00 (Reporting by Herbert Lash; Editing by Arun Koyyur and Will Dunham)