TREASURIES-Bond prices inch higher on potential for dovish Fed

* Fed to hold policy meeting Tuesday, Wednesday

* Recent dollar surge seen affecting Fed

* Low volume, U.S. stock rally cap Treasury price gains (Recasts throughout to add comments, updates prices)

By Sam Forgione

NEW YORK, March 16 (Reuters) – U.S. Treasuries prices edged higher on Monday on speculation the Federal Reserve could take a more cautious tone at its policy meeting this week, while low trading volume and a rally in U.S. stocks capped gains.

The policy-setting Federal Open Market Committee meets on Tuesday and Wednesday and has been widely expected to drop the word “patient” from its formal statement on the timing of its first interest rate increase since 2006.

Analysts said the rally in the dollar could lead the Fed to reconsider removing the term, however, given the negative impact of the stronger currency on economic competitiveness and inflation in the United States. The dollar has risen about 24 percent against a basket of currencies since May.

“It’s only a matter of time before the Fed will certainly address the strength of the dollar,” said Edward Acton, Treasury strategist at RBS Securities in Stamford, Connecticut.

Weaker-than-expected economic data on U.S. manufacturing, industrial output and housing on Monday bolstered the view the Fed could maintain an accommodative stance on monetary policy.

“The data today were pretty weak,” said David Keeble, global head of interest rates strategy at Credit Agricole Corporate & Investment Bank in New York. Fed policymakers “certainly have an escape route if they need it.”

He also noted last week’s data showing U.S. retail sales unexpectedly fell in February.

Reluctance to make significant bets ahead of the Fed’s meeting kept trading subdued and likely exaggerated the modest gains in Treasuries prices, analysts said. Analysts also said a rally in riskier U.S. equities capped demand for safe-haven Treasuries.

Just 686,402 contracts of 10-year T-note futures changed hands as of 3:47 p.m. ET (1947 GMT), on track for the lowest daily volume since late December.

Benchmark 10-year U.S. Treasury notes were last up 6/32 in price to yield 2.09 percent, from a yield of 2.11 percent late Friday. U.S. 30-year Treasury bonds were last up 20/32 in price to yield 2.66 percent, from a yield of 2.69 percent late Friday.

U.S. two-year Treasury notes were last flat in price to yield 0.653 percent after earlier hitting 0.637 percent, their lowest yield level since March 6.

On Wall Street, the benchmark S&P 500 was last up 1.3 percent, marking a rebound after three weeks of losses.

(Editing by Meredith Mazzilli and Andre Grenon)

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