TREASURIES-Yields rise before five-year note sale
* Prices fall as housing, other data improves
* Treasury will sell $35 bln in five-year notes on Wednesday
* Volatility increases to highest since November 2011
NEW YORK, June 25 (Reuters) - The Treasury sold new two-year notes on Tuesday at the highest yields in two years, adding to speculation that prices might need to continue to weaken to attract demand for a five-year note sale on Wednesday. The government sold $35 billion in two-year notes at a yield of 0.43 percent, the highest since May 2011, in its first sale of $99 billion in new coupon-bearing supply this week. The debt auctions come at a tricky time for investors after a dramatic selloff sent yields to their highest in almost two-years on fears the Federal Reserve is closer to reducing its bond purchase program, which many worry will send rates still higher. Wednesday's $35 billion, five-year note sale will test demand even at dramatically higher yields. The five-year and seven-year notes are the most sensitive to the Fed's interest rate policy and have been the worst Treasuries performers in the recent selloff. "Five-year and seven-year notes have underperformed. They have really felt the deleveraging process more than other issues on the curve, particularly in front of quarter-end," said Russ Certo, managing director and head of Treasuries trading at Brean Capital, in New York. Balance sheet-tidying ahead of quarter-end will add a wild card to the sale. Treasuries are often seen as a relatively low risk investment for quarter-end, but the recent volatility might make investors unwilling to risk mark-to-market losses and prefer to hold onto cash instead. "If people are going to deploy capital and cash to find value and think bonds will stabilize, that would be the place you would do it," Certo said. "But you're certainly contending with a broad liquidation and redemptions from funds and technicals that are challenging." Traders expect the new five-year notes to price at yields of 1.50 percent, according to trading in the "when-issued" market, around three basis points higher than the notes are trading in the secondary market at 1.47 percent . U.S. benchmark 10-year Treasury notes were last down 14/32 in price to yield 2.59 percent, up from 2.544 percent late on Monday, but down from their high of 2.67 percent reached earlier on Monday. Thirty-year bonds fell 1-3/32 in price to yield 3.61 percent compared with 3.56 percent late on Monday. These yields reached as high as 3.65 percent on Monday. Bond volatility measures have also continued to increase. The Merrill Lynch MOVE index, which estimates future volatility of long-term bond yields, increased to 111 on Monday from 103.7 on Friday, its highest level since November 2011. It is up from a multi-year low of around 50 at the beginning of May. Tuesday's two-year note sale also came after robust economic data led prices downward as investors speculated Fed Chairman Ben Bernanke's projection of an improving economy might be correct, making it more likely bond purchases will be reduced. Existing single-family home prices recorded their biggest gain in seven years in April and U.S. consumer confidence jumped in June to its highest in over five years. Orders for long-lasting U.S. manufactured goods also increased more than expected in May and a gauge of planned business spending rose for a third straight month.
Those figures could confirm expectations the Fed's bond buying program will slowed, said Michael Hanson, senior economist at Bank of America Merrill Lynch in New York. At the same time, the market might be getting ahead of the likely timetable when the Fed starts paring purchases. "We are not expecting the Fed to announce tapering until December, even though others are calling for earlier," Hanson said. "The Fed is eager to scale back a little, while the market has priced in a rapid exit." The Fed on Tuesday bought $1.46 billion in bonds due 2036 to 2042 as part of its ongoing purchase program. It will buy between $2.75 billion and $3.50 billion in notes due 2020 and 2023 on Wednesday.