Treasuries Drop Before $35 Billion 2-Year Note Sale on Fed View

Treasuries fell, extending their biggest loss in more than two years, before a report forecast to show U.S. consumer confidence jumped in May to a six-month high, fueling bets the Federal Reserve will slow monetary stimulus.

Treasury 10-year yields traded at almost the highest level since March before the U.S. auctions $35 billion of two-year notes in the first of three sales this week totaling $99 billion. Government securities have lost 1.3 percent in May, set for the steepest drop since December 2010, according to Bank of America Merrill Lynch indexes. Fed Chairman Ben S. Bernanke said last week the central bank may cut the pace of asset purchases if officials see indications of sustained economic growth.

“The focus is going to be on supply,” said Sean Murphy, a trader at Societe Generale SA in New York, one of the 21 primary dealers that trade with the Fed. “That’s probably the majority of why we’re softer. You’re probably seeing a little more reaction to Bernanke’s comments.”

Benchmark 10-year yields climbed four basis points, or 0.04 percentage point, to 2.05 percent at 8:43 a.m. New York time, according to Bloomberg Bond Trader data. The 1.75 percent note due May 2023 slid 11/32, or $3.44 per $1,000 face amount, to 97 10/32. The yield reached 2.07 percent on May 23, the highest level since March 14.

Trade in U.S. government securities was closed yesterday for a holiday.

Yield Indications

The two-year notes scheduled for sale today yielded 0.26 percent in pre-auction trading, up from a rate of 0.233 percent at a previous sale on April 23.

The U.S. is due to auction $35 billion of five-year debt tomorrow and $29 billion of seven-year securities on May 30.

Trading volume at ICAP Plc, the largest inter-dealer broker of U.S. government debt, surged to $662.3 billion on May 22, the day Bernanke said in testimony to Congress that policy makers may cut the pace of bond purchases at the next few meetings if they see signs the economy’s growth is sustainable. That was the highest level in data going back to 2004. The previous high was $621.8 billion in August 2007. ICAP’s average daily volume for this year has been $292.8 billion.

The Fed is buying $85 billion of Treasury and mortgage debt a month, a policy known as quantitative easing, to support the economy by putting downward pressure on borrowing costs. The central bank plans to buy as much as $1.75 billion of Treasuries maturing from February 2036 to May 2043 today.

Fed Outlook

“If we see continued improvement and we have confidence that that is going to be sustained, then we could in -- in the next few meetings -- we could take a step down in our pace of purchases,” Bernanke told lawmakers last week.

The Conference Board’s sentiment index climbed to 71.2 this month from 68.1 in April, according to the median prediction of 75 economists in a Bloomberg News survey. That would be the highest reading since November’s 71.5.

The S&P/Case-Shiller index of property values increased 10.9 percent from March 2012, the biggest 12-month gain since April 2006, after advancing 9.4 percent in February, a report showed today in New York. The median projection of 30 economists surveyed by Bloomberg called for a 10.2 percent advance.

Unemployment at 7.5 percent and a 1.1 percent inflation rate are helping keep yields and volatility in check.

“Coming into this week, sentiment in bond markets wasn’t good as we tested important levels already” in both Treasuries and German bunds, said Piet Lammens, head of research at KBC Bank NV in Brussels. “The decline in bond markets was already well under way when Bernanke spoke but certainly it helped.”

Inflation Expectations

Treasury declines may accelerate should the 10-year yield jump above a possible cluster of buy orders at 2.09 percent, with the risk that rates may climb toward 2.40 percent, Lammens said.

Treasury Inflation-Protected Securities show investors anticipate an average increase of 2.27 percent in consumer prices for the next decade, up from 2.23 percent on May 23, which was the least since Aug. 9.

The Fed’s preferred measure of inflation, the personal consumption expenditures deflator, fell in April for a second month by 0.2 percent, according to the median forecast of 32 economists in a Bloomberg News survey. The Bureau of Economic Analysis will report the data May 31.

Bank of America Merrill Lynch’s MOVE Index, which tracks option projections for the pace of swings in Treasuries maturing in two to 30 years, fell to a record 48.87 on May 9. The index rose to as high as 68.2 last week, below the average of 96.6 since 2006.

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