Treasuries Decline Before $35 Billion Auction of Two-Year Notes

Treasuries fell before the U.S. government sells $35 billion in two-year securities in the first of three note offerings this week totaling $99 billion.

Benchmark 10-year note yields rose for the first time in four days as a government report showed sales of new homes unexpectedly increased last month.

“There’s a little more optimism,” said Anthony Cronin, a Treasury trader in New York at Societe Generale, one of the 20 primary dealers obliged to participate in U.S. debt auctions. “People take a step back and look at buying two-year notes at about 60 basis points, and the appetite just may not be there.”

The 10-year note yield gained two basis points, or 0.02 percentage point, to 3.15 percent at 12:28 p.m. in New York, according to Bloomberg Bond Trader prices. The 3.125 percent security due in May 2021 dropped 5/32, or $1.56 per $1,000 face amount, to 99 25/32.

The yield on the 10-year note decreased on May 18 to 3.09 percent, the lowest level since Dec. 7. The two-year note yield was little changed at 0.52 percent today after touching 0.50 percent yesterday, the lowest level since Dec. 7.

Crude oil for July delivery gained 0.8 percent to $98.46 a barrel. The S&P 500 Index slid 0.1 percent after falling 1.2 percent yesterday, the most in two months.

New Home Sales

Sales of U.S. new homes unexpectedly increased 7.3 percent in April to a 323,000 annual pace, a four-month high, the Commerce Department reported today. The median forecast of 75 economists in a Bloomberg News survey was for no change. A Federal Reserve Bank of Richmond gauge of manufacturing in the Carolinas, the District of Columbia, Maryland, Virginia and West Virginia dropped this month more than forecast to negative 6.

The yield on 10-year Treasuries has fallen below the annual inflation rate this month for the first time since 2008, making the securities less attractive. The spread, known as the real yield, was negative four basis points today.

The consumer price index increased 3.2 percent in the 12 months ended in April, the biggest gain since October 2008, figures from the Labor Department showed this month. The so-called core measure excluding food and energy rose 1.3 percent from April 2010.

“In the short term, with CPI where it is, negative real yields are very difficult to justify without a lot of fear,” said Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London.

Two-Year Auction

The two-year notes scheduled for sale today yielded 0.57 percent in pre-auction trading. Investors bid for 3.06 times the amount of available debt on April 26, compared with the average of 3.38 for the past 10 auctions.

Indirect bidders, which include foreign central banks, bought 37.9 percent of the securities, versus the 10-sale average of 33.1 percent. Direct bidders, non-primary dealers buying for their own accounts, purchased 13.3 percent.

“Auctions increase supply, and so are negative for Treasuries,” said Tomohisa Fujiki, an interest-rate strategist in Tokyo at a unit of BNP Paribas, a primary dealer. “There’s a bit of caution about high prices for Treasuries.”

In addition to today’s sale, the U.S. will auction $35 billion of five-year securities tomorrow and $29 billion of seven-year debt May 26.

Treasuries have returned 1 percent in May in what would be a second straight monthly advance, according to an index compiled by Bank of America Merrill Lynch.

Bullard’s View

St. Louis Fed President James Bullard said the central bank may keep its policy rate, the size of its balance sheet and policy language the same when asset purchases end in June.

Past behavior of the policy board “indicates that the Committee sometimes puts policy on hold,” Bullard said yesterday in Farmington, Missouri. A pause “gives the Committee more time to assess economic conditions,” he said.

Fed funds futures indicated a 15 percent chance the Fed will raise its target lending rate by December, down from a 24 percent probability a month ago. The benchmark has held at zero to 0.25 percent since December 2008.

The central bank purchased $6.4 billion of bonds due from November 2013 to May 2015 today under the $600 billion program of debt purchases ending next month.

Portuguese 10-year yields surged to a record high of 9.85 percent on concern Europe’s debt crisis is worsening, while Belgian securities also fell after Fitch ratings warned yesterday it may cut the nation’s rating.

“It’s risk-on to a small degree, but Treasuries aren’t going to lose a lot of their premium because I don’t think any of these issues have been solved,” said John Briggs, a U.S. government bond strategist in Stamford, Connecticut, at RBS Securities Inc., a primary dealer. “What we’re just seeing is a little bit of froth being taken off the Treasury market.”

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