TREASURIES-Traders hit the brakes on bond selling as stocks drop

SYDNEY, Jan 21 (Reuters) - Treasuries rallied for a third straight session on Friday as a steep sell-off in stock markets prompted investors to seek safety in bonds and temper some bets on Federal Reserve rate hikes.

Benchmark 10-year U.S. yields fell 3.5 basis points (bps) to 1.7755% by mid-session in Tokyo, down more than 12 bps from Wednesday's two-year high.

Yields on the five-year, 20-year and 30-year tenors also dropped for a third session in a row, while two-year yields fell for a second day and briefly pushed below 1%.

"The stock market's getting the shit punched out of it, so that's helping moderate 10-year yields," said Commonwealth Bank of Australia's head of fixed income and currency strategy, Martin Whetton. Yields fall when bond prices rise.

The tech-heavy Nasdaq is in correction territory, down more than 10% from a November peak, while the S&P 500 has fallen more than 7% from a January high.

"It's risk sentiment," said Whetton.

"We all know that there's some strong growth going on and there's some inflation going on," he added, but said that while the economy faces headwinds from the Omicron virus variant, policymakers will probably feel constrained. The 10-year yield could chop around below 2% for quite a while, he reckoned.

Geopolitical uncertainty has also put safe assets in favour as tensions grow between Russia and the West over Ukraine.

Fed funds futures were up slightly on Friday, but still priced for a hike in March and four hikes in total this year.

The two-year yield was last at 1.0158% and the gap between the 10-year and two-year yields shrunk two bps to its narrowest for the calendar year at 75.5 bps.

Five-year yields were down 3 bps to 1.5604% and the 30-year yield fell 2.8 bps to 2.0950%.

The Federal Reserve meets next week to set policy. (Reporting by Tom Westbrook; Editing by Subhranshu Sahu)

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