July 29 (Bloomberg) -- Treasury notes fell after a government auction of a record amount of notes drew higher-than- forecast yields for a second consecutive day, renewing concern a deluge of U.S. debt will overwhelm investor demand.

The $39 billion in five-year notes yielded 2.689 percent, more than 2.635 percent median forecast of eight primary dealers surveyed by Bloomberg News. Investors also demanded higher yields on yesterday’s $42 billion of two-year notes. Interest from an investor class that includes foreign central banks declined at each of the auctions from last month, when those sales attracted the most bids in at least six years.

“You’re starting to see customers pull back from the market,” said Thomas L. di Galoma, head of U.S. rates trading at Guggenheim Capital Markets LLC, a New-York based brokerage for institutional investors. “It’s been a fundamental shift in central bank buying.”

The yield on the existing five-year note rose three basis points, or 0.03 percentage point, to 2.64 percent at 5:20 p.m. in New York, according to BGCantor Market Data. The 2.625 percent security maturing in June 2014 fell 5/32, or $1.56 per $1,000 face amount, to 99 30/32.

Two-year note yields climbed eight basis points to 1.16 percent, while yields on three-year securities increased four basis points to 1.68 percent.

The 10-year note yield fell two basis points to 3.67 percent after earlier rising as much as five basis points. The difference between 2- and 10-year notes fell 0.12 percentage points to 2.49 percent, the lowest level in over two weeks.

‘Point of Saturation’

Indirect bidders bought 36.7 percent of the five-year notes, down from 62.8 percent of the securities at the June sale, the highest since December 2004. This class of investors bought 33 percent of the two-year notes sold yesterday, compared with 68.7 percent previous auction in June. That was the most in at least six years.

The bid-to-cover ratio, which gauges demand by comparing total bids with amount of securities offered, was 1.92. At the June 24 auction, the notes drew a yield of 2.7 percent, the highest since October.

“The total bids are not extraordinary -- what’s extraordinary is the size of the issue,” said William O’Donnell, U.S. government bond strategist at RBS Securities Inc. in Stamford, Connecticut, one of 18 primary dealers required to bid at Treasury auctions. “We’ve just reached the point of saturation in the marketplace, clearly, and it’s just made it very difficult to get these things done.”

Auction Tail

Today’s sale was the third of four auctions totaling $115 billion that is the largest amount of so-called coupon securities sold in a single week. The government is scheduled to sell $28 billion of seven-year notes tomorrow.

The auction’s tail, or amount of yield in excess of where the security was trading before the sale, was 5.4 basis points, or the most on a five-year offering since February 1993, according to data from O’Donnell.

Longer maturity debt benefited as the Fed bought $2.999 billion of Treasuries maturing between February 2021 and February 2026, part of its plan to capping borrowing costs.

“Going outside the back end, given what the curve is doing, is not a good idea,” said Thomas Roth, head of U.S. government bond trading in New York at Dresdner Kleinwort. “Supply is a big thing to handle. The Street is getting socked with a lot of paper.”

The central bank has bought $222.719 billion in U.S. debt since its purchases began on March 25.

Record Borrowing

The U.S. raised $1.02 trillion this year selling Treasury securities to help finance a recovery from the recession, government data show. In its next round of auctions, the U.S. will sell three-, 10- and 30-year securities on three consecutive days beginning Aug. 11.

Goldman Sachs Group Inc. said the U.S. will sell about $2.9 trillion of debt in the two years ending September 2010, cutting its estimate for Treasury auctions by 28 percent, as the economy improves.

President Barack Obama will sell a net $1.9 trillion of debt in the current fiscal year that ends Sept. 30, Goldman said in its report late yesterday. In March it forecast $2.7 trillion. Goldman, also a primary dealer, trimmed its projection for sales the next fiscal year to $1 trillion from $1.35 trillion, wrote Ed McKelvey, senior U.S. economist in New York.

The U.S. federal deficit will be $1.725 trillion for this fiscal year and $1.4 trillion in the following 12 months, McKelvey wrote. In March, Goldman estimated the figures at $1.86 trillion and $1.5 trillion.

Treasuries lost 0.5 percent this month, compared with a 0.3 percent advance for German government bonds, according to Merrill Lynch & Co. indexes.

The financial crisis, which started with the collapse of the U.S. property market in 2007, has triggered $1.52 trillion of writedowns and credit losses at banks and other institutions and sent the global economy into its first recession since World War II. The government and the Fed have spent, lent or committed more than $12 trillion in a bid to revive the economy and credit markets.

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net; Daniel Kruger in New York at dkruger1@bloomberg.net

Last Updated: July 29, 2009 17:24 EDT