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Treasuries Drop for a Second Day Amid Budget Talks, Note Auction

Treasuries slid for a second day as investors bet U.S. leaders will resolve a budget showdown and the U.S. sold $35 billion of five-year debt to the lowest demand in five months.

Thirty-year bond yields climbed to a three-month high as President Barack Obama and House Speaker John Boehner negotiated to end a stalemate that could push the economy into recession next year. Yields on five-year securities climbed to the highest level in seven weeks as the sale, the second of four note offerings this week totaling $113 billion, drew bids for 2.72 times the amount offered, the least since July.

“The market’s definitely feeling like there’s more potential for an agreement than that we reach Dec. 31 and fail,” said Justin Lederer, an interest-rate strategist at Cantor Fitzgerald LP in New York, one of 21 primary dealers that are required to bid at government-debt auctions.

Thirty-year yields climbed five basis points, or 0.05 percentage point, to 3 percent at 5 p.m. in New York, according to Bloomberg Bond Trader Prices. They reached 3.03 percent, the highest since Sept. 17. The price of the 2.75 percent security due in November 2042 dropped 1, or $10 per $1,000 face amount, to 95 1/8.

The yield on the current five-year note increased three basis points to 0.76 percent and reached 0.78 percent, the most since Oct. 31. Benchmark 10-year yields touched 1.85 percent, the highest level since Oct. 25, before trading at 1.82 percent.

Technical Support

The 10-year note yield has technical support at 1.83 percent, which it failed to keep above on Oct. 25-26, the last time it reached the level, Lederer said. There’s additional demand at 1.88 percent, the top of the security’s range since September, he said.

The yield breached 1.75 percent yesterday, its 200-day moving average. It touched 1.56 percent on Dec. 6, the lowest this month.

“I expect the range to hold right now,” said Michael Cloherty, head U.S. interest-rate strategist at Royal Bank of Canada’s RBC Capital Markets unit in New York, a primary dealer. “The danger around here is the range has held for so long, if you break it the next stop is a ways away.”

Treasuries fell even after Obama rejected an alternative budget plan proposed by Boehner in talks to resolve the fiscal showdown.

The president lowered his tax revenue demand yesterday by $200 billion and offered to start tax-rate increases at $400,000 in income instead of $250,000. The House speaker told reporters today Obama is “not there yet” on a balanced approach. Boehner said he’ll push a budget “plan B” measure that will include tax increases on income of more than $1 million a year. White house spokesman Jay Carney said it isn’t credible.

Still Optimistic

“Even with some of the public political banter, markets still feel optimistic there will be an agreement,” said Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG, a primary dealer. “There has been a lot of movement over the last few days. People are still continuing to be optimistic and the base-case scenario is that there will be a resolution.”

More than $600 billion in tax boosts and spending cuts will automatically start taking effect in January unless an accord is reached. Failing to avert the fiscal cliff may push the economy in recession, according to the Congressional Budget Office.

Auction Yield

The five-year notes sold today yielded 0.769 percent, compared with a forecast of 0.772 percent in a Bloomberg News survey of seven primary dealers. The record five-year auction low was 0.584 percent at the July offering. It reached a 2012 high of 1.040 percent at the March sale.

Direct bidders, non-primary dealer investors that place their bids directly with the Treasury, purchased 30.4 percent of the notes, the most since September 2004.

Primary dealers bought 37.2 percent of the notes, the least since April 2010.

Indirect bidders, an investor class that includes foreign central banks, purchased 32.4 percent, versus an average of 42.1 percent at the past 10 sales.

Five-year notes have returned 2.1 percent this year compared with a 2 percent gain by Treasuries overall, according to Bank of America Merrill Lynch indexes. The five-year securities rose 9.2 percent in 2011, while Treasuries overall advanced 9.8 percent.

The government auctioned $35 billion of two-year notes yesterday at a yield of 0.245 percent. It will sell $29 billion in seven-year securities tomorrow and $14 billion of five-year Treasury Inflation-Protected Securities on Dec 20.

The Federal Reserve bought $1.7 billion of Treasuries today maturing from February 2036 to November 2042. It sold $7.6 billion of U.S. debt due in 2015. The transactions were part of Operation Twist, under which the central bank replaces shorter-maturity notes in its holdings with longer-term debt.

The program will expire this month, and the Fed will start buying Treasuries next year in an expansion of a quantitative-easing round.

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