TREASURIES-Two-year notes risk higher yields on payrolls, Fed

* Two-year notes price with 1 bp tail in $35 bln auction

* Short-term debt may sell off on strong payrolls

* End of Fed’s QE program seen weighing on Treasuries
(Recasts, adds quotes, updates prices)

By Karen Brettell

NEW YORK, March 28 (Reuters) – Two-year notes may be among
the Treasuries most at risk of a sell-off if employment data
this week beats expectations.

A $35 billion auction of two-year notes priced with a one
basis point tail on Monday, though traders said this may have
been due to investors cleaning books ahead of quarter end.

A bigger risk to yields will be if data on Friday show that
employers added more than the currently expected 190,000 jobs
to their payrolls in March.

“We think there is a strong possibility of an upside
surprise in payrolls, which will likely cause front-end yields
to rise substantially,” analysts at JPMorgan said in a report.

Two-year notes (US2YT=RR: Quote, Profile, Research) were last down 2/32 in price to
yield 0.78 percent, up from 0.74 percent late on Friday.
They could be at risk as the Federal Reserve unwinds its
stimulus program and paves the way for higher rates.

CROWDED TRADES

One reason two-year notes may be vulnerable is that the
number of investors holding long positions in short-term
Treasuries has increased, and the need to cover these positions
in any sell-off may exacerbate market moves, said JPMorgan.

Futures data by the Commodity Futures Trading Commission
indicates that long positions among “speculative” accounts,
including hedge funds, are at four-month highs.

Mutual funds, meanwhile, appear concentrated in
yield-curve-steepening trades, in which they are significantly
long near-term maturities and short 10-year notes.

These trades are “an especially crowded position,” JPMorgan
said. “If a large upside surprise were to occur, we would view
front-end longs and curve-steepening positions as especially
vulnerable in the current environment.”

History also shows that popular carry trades such as these
have sold off the most when payrolls have beaten expectations.

On each of the last seven occasions since 2009 that
payrolls have surprised to the upside, three-year and five-year
Treasuries yields, which had the most carry trades, rose by an
average 10 basis points that day, JPMorgan said.

So-called “red” Eurodollars, meanwhile, sold off an average
of 15 basis points, wiping out nearly two months of carry.

These “red” contracts, which expire between June 2012 and
March 2013, were among the worst performers on Monday. Futures
that expire in March 2013 (EDH3 : Quote, Profile, Research) fell 7 ticks to 97.78, but
saw technical support at around 97.76.

QE END MAY SEND YIELDS HIGHER

The expected end of the Fed’s quantitative easing program
in June may also send short-term rates higher, analysts said.

Technical analysts at Credit Suisse view two-year notes as
among the most at risk.

“Two-year U.S. yields may not be that far away from what
should be a significant bearish break, which would not only
clear the way for an outright sharp move higher, but also a
significant flattening move,” analysts, including David
Sneddon, said in a report.

“Although we have to see a break of key support, we are
alert to this potentially occurring soon,” he added.

A break above the notes’ current yield support at around
0.86 percent to 0.90 percent could send yields swiftly to the
1.20 percent area, he said.

Five-year and seven-year notes also weakened ahead of
planned auctions of the notes on Tuesday and Wednesday.

Five-year notes (US5YT=RR: Quote, Profile, Research) were down 6/32 in price to yield
2.20 percent, up from 2.16 percent, and seven-year notes
(US7YT=RR: Quote, Profile, Research) fell 6/32 in price to yield 2.86 percent, up from
2.84 percent. Benchmark 10-year notes (US10YT=RR: Quote, Profile, Research) dropped 4/32
in price to yield 3.46 percent, up from 3.44 percent.
(Editing by Dan Grebler)

TREASURIES-Two-year notes risk higher yields on payrolls, Fed