* Prices fall as stocks recover
* 10-year yields break above support, add to sell pressure
* Treasury auctions $35 billion two-year notes in tepid sale
* Fed buys $1.45 billion in bonds due 2036-2043
By Luciana Lopez and Karen Brettell
NEW YORK, May 28 (Reuters) – Yields on U.S. Treasuries
surged to a 13-month peak on Tuesday as stocks hit another
record high and investors, worried the Fed could slow its
massive bond-buying program, proved reluctant to buy more U.S.
debt in an auction of two-year notes.
Selling gained steam throughout the session, boosting the
30-year yield to 3.331 percent, the highest since April 2012.
A tepid performance for two-year notes in a Treasury
auction, with a higher-than-expected yield and less bidding than
average, underscored investor views that the U.S. Federal
Reserve could soon taper its $85-billion-per-month asset buying
as the economy improves.
The weak auction came the same day data showed a jump in
U.S. home prices and surging consumer confidence.
“People are feeling more flush, and that might get the Fed
thinking this might be sustainable and it’s time to turn the
dial down a notch,” said William O’Donnell, head Treasury
strategist at RBS Securities in Stamford, Connecticut.
“The market’s trying to find its footing.”
O’Donnell noted increasing fears of mortgage convexity and
extension fears among traders long in mortgage-backed
securities.
Essentially, investors in mortgage securities, anticipating
accelerated prepayment risk, will sell bonds to get ahead of
such moves.
Tuesday’s auction could also bode ill for a Wednesday sale
of five-year notes, said Jim Vogel, an interest rate strategist
at FTN Financial in Memphis, Tennessee.
“If we’re really that sour on Treasuries, you wonder how
cheap 5s have to be,” he said. “This will be a very attentively
watched 5-year auction tomorrow.”
Yields have jumped since Fed Chairman Ben Bernanke said on
Wednesday that the U.S. central bank might decide to gradually
decrease its bond purchases in the next few policy meetings if
data shows the economy is gaining steam.
In addition, traders now see January 2015 as the likely
first Fed rate increase, giving it a 55 percent chance, based on
short-term interest rate futures traded at CME Group.
“The market is jittery. Any sign of a potential pullback
from the Fed or of stronger data and you are going to see a
sharp move like we did in the past week,” said Sean Simko,
portfolio manager at SEI Investments in Oaks, Pennsylvania. “The
path of least resistance is higher yields.”
Benchmark 10-year yields broke above technical support at
around 2.07 percent on Tuesday, causing a second wave of selling
that sent yields to their highest levels since April 2012.
The notes were last down 1-14/32 in price to
yield 2.172 percent, up from 2.01 percent on Friday. Yields,
which move inversely to price, have surged from 1.61 percent at
the beginning of May as optimism about the economy has grown.
Thirty-year bonds fell 2-26/32 in price to yield
3.331 percent. The yields are up from 3.18 percent on Friday.
Both the 10-year notes and 30-year bonds are on track for
their worst monthly loss since December 2009.
Barclays’ iShare ETF on Treasuries dated 20 years and
over was down 1.4 percent, bringing its month-to-date loss to
6.4 percent.
Japanese and U.S. stocks recovered on Tuesday from recent
weakness, reducing the safety bid for U.S. bonds.
“The strength of the stock markets internationally and in
the U.S. is putting Treasuries under pressure,” said Lou Brien,
market strategist at DRW Trading in Chicago.
Some analysts and investors, however, have said the market
might be oversold and that the Fed’s comments that the central
bank could also increase the size of its purchases have been
overlooked.
Falling inflation measures are also leading some investors
and analysts to speculate the Fed might increase the scale of
its bond purchases on fears about disinflation or falling prices
rather than reduce them on an improving labor market.
“I think we’re closer to a threshold on inflation than we
are to a threshold on the labor market,” said Brien.
The release of April’s Personal Consumption Expenditures
index on Friday, the Fed’s favored inflation gauge, will be
closely watched for a further drop in price inflation.
The index has fallen to a 3 1/2-year low of 1.0 percent.
Treasuries might come under further pressure this week as
banks and investors prepare to absorb $99 billion in new
coupon-bearing supply. Besides Tuesday’s $35 billion auction of
two-year notes, there will be sales of $35 billion of five-year
notes on Wednesday and $29 billion of seven-year notes on
Thursday.
The Fed bought $1.45 billion in bonds due from 2036 and 2043
on Tuesday as part of its purchasing program to stimulate the
economy.
(Additional reporting by Richard Leong in New York and Ann
Saphir in San Francisco; Editing by Kenneth Barry, Andrew Hay
and Andre Grenon)
