NEW YORK, Dec 21: US Treasury prices edged lower on Friday as most investors took to the sidelines after a three-day run-up and as traders watched the stock market rack up some modest gains.

But the threat of a possible U.S. war on Iraq kept an underlying bid in the safe-haven government bond market, leaving prices only marginally lower compared with Thursday’s closing levels. Yields on two-year notes traded not far above record lows hit in October.

Wall Street bond trading desks were very thinly staffed as many left early before the Christmas holiday week. That left the Treasury market mostly adrift and traders cautioning there was little to be gleaned from a slight dip.

The liquidity has been poor, said Andrew Brenner, head of institutional bond trading at Investec, as pricing screens went nearly dead, with very few securities changing hands.

The strong tone of the stock market has kept the bond market on the defensive, Brenner said.

Shorter-dated maturities also succumbed to selling pressure in anticipation of a $27.0 billion two-year note auction scheduled for Monday morning. Before an auction, dealers often “cheapen” existing issues, raising their yield, to make the new issues more attractive to customers.

Two-year notes slipped 2/32 to 100-15/32 for a yield of 1.75 per cent, up from 1.71 per cent. But two year yields fell about 10 basis points on the week in part from investor fears the US is preparing for war. Late on Friday, the when-issued two year traded near 1.79 per cent.

On Wall Street, meanwhile, the Dow Jones industrial average closed up 1.75 per cent, drawing funds away from the bond market.

Given the run up Treasuries have had over the last few days, we’re naturally seeing some profit-taking, said Anthony Karydakis, senior financial economist at Banc One Capital Markets in Chicago.

Treasuries marched up for most of the week, accelerated after the White House said on Thursday Iraq was in “material breach” of a Security Council resolution to identify any banned weapons.

That helped Treasuries break out of a well-defined range topped at 113-10/32 on Thursday, with March 10-year futures settling well above that level on Friday at 113-25/32. Many analysts expect the market to forge higher, with next resistance at 114-9/32, a high struck on Nov. 12.

I don’t expect to see too much more of a deterioration in prices just because we continue to have uncertainty over Iraq, said Gemma Wright, market strategist at Barclays Capital.

Late on Thursday, Federal Reserve Chairman Alan Greenspan said the US economy still is working through a soft patch but growth should accelerate next year if global tensions ease. His comments that had little net impact on the bond market.—Reuters