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Yields Rise to Highest Level in Over a Year

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Yields on U.S. Treasurys 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.

(Read More: Stocks End Higher, Dow Closes at Record High)

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," he said.

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 Treasurys, 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 may 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 Jan 2015 as the likely first Fed rate hike, 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 Treasurys 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 Treasurys under pressure," said Lou Brien, market strategist at DRW Trading in Chicago.

Some analysts and investors, however, have said that the market may 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 that the Fed may 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.

Treasurys may 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.

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