U.S. debt prices fall ahead of 2-year supply

By Brenda Goh and Richard Leong

LONDON/HONG KONG (Reuters) – U.S. Treasuries fell on Monday, weighed down by hawkish comments from Federal Reserve officials over the weekend, with further pressure from traders pushing for concessions before a $35 billion two-year note sale.

The June T-note future fell 21/64 to 118-55/64, as growing concerns that the Fed could tighten its ultra-loose monetary policy earlier than expected took the market’s focus away from turmoil in the Middle East and Japan’s nuclear crisis.

“The geopolitical has taken a back seat because what we’re concentrating on … is the (Fed) decision makers and what their rhetoric has been recently. And it’s been uniformly hawkish,” a trader said.

St. Louis Fed President James Bullard said on Saturday that lengthening the “extended period” of low interest rates could encourage a liquidity trap. His remarks followed comments from Philadelphia Fed chief Charles Plosser, who said on Friday that the Fed would have to raise rates “in the not-too-distant future.

More Fed officials will speak on Monday, including Atlanta Fed President Dennis Lockhart, Chicago Fed chief Charles Evans and Boston Fed President Eric Rosengren. Of the three, only Evans is a voting member of the Fed’s rate-setting group in 2011.

U.S. interest rate futures implied that traders are pricing back the chances of the Fed raising rates in the first quarter of 2012 after severely discounting them two weeks ago shortly after Japan’s devastating earthquake and tsunami. Traders had bet on a heavy toll on global growth from the Japan disaster, which would discourage the Fed from raising rates in early 2012.

“It’s more of a safe-haven unwind than anything else at this point,” said Charles Diebel, strategist at Lloyds Bank.

“The risk from here is still toward high yields. Certainly if you look at the yield basis for the 10-year note toward 3.60, is where you’ve got pretty good support, so I think you could drift toward that area, obviously subject to headline risk as we go along,” he said.

The yield on benchmark 10-year T-notes was last up 3.7 bps at 3.478, while the 2-year yield was 3.7 bps higher at 0.773.

Most analysts expect healthy demand for the two-year debt supply, part of the $99 billion worth of debt on offer this week.

“The sector has cheapened in (relative value), with the 1s2s3s fly cheapening some five bps, and historically, these auctions have strong cover ratios and cleared through prevailing market levels,” said Barclays Capital analyst Moyeen Islam in a note.

In the “when-issue” sector, traders expect the U.S. Treasury Department to sell the new two-year issue at a yield close to 0.80 percent, the highest since April 2010. The two-year auction will be released shortly after 1700 GMT.

(Editing by Hugh Lawson)

U.S. debt prices fall ahead of 2-year supply