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TREASURIES-Bonds drop further after weak auction as Fed awaited

Ellen Freilich
Wednesday, 18 Dec 2013 | 1:01 PM ET

* Treasury sale gets light bid before Fed statement

* Rise in U.S. housing starts shows resiliency -economists

NEW YORK, Dec 18 (Reuters) - U.S. Treasuries prices extended losses on Wednesday after a lightly bid five-year Treasury note auction and amid caution just hours before the Federal Reserve releases its policy statement at the close of its two-day meeting.

The value of bids received for the five-year auction exceeded those accepted by a subdued 2.42 ratio.

"The five-year note auction was terrible," said John Canavan, analyst at Stone & McCarthy Research Associates in Princeton, New Jersey. "The buyside demand was atrocious, and indirect bidders in particular avoided this auction like the plague."

Prices of U.S. government bonds had fallen earlier after the Commerce Department reporter stronger-than-expected U.S. housing starts in November, which fit a recent pattern of improved economic data that could make it easier for the Fed to begin trimming its large-scale asset purchases aimed at stimulating economic growth.

"All eyes are on the Federal Reserve announcement at two o'clock, with a number of market participants increasing their odds for tapering given positive labor market and growth data over the past several weeks," said Jake Lowery, Treasury trader and portfolio manager for global interest rates at ING U.S. Investment Management.

The Fed will release its policy decision at 2 p.m. (1900 GMT), followed by a press conference by Fed Chairman Ben Bernanke at 2:30 p.m., his final press conference as Fed chief.

Daniel Heckman, senior fixed income strategist at U.S. Bank Wealth Management in Kansas City, Missouri, said the evidence that "so far higher rates have not had a real detrimental impact on housing," combined with other recent stronger data, including the employment report for November, give the Fed the flexibility to make a move.

"Our official stance is January, but we would not be surprised if something did get announced today, along with 'forward guidance' to make sure the markets remain orderly and there is no rush for the exits," Heckman said.

Krishna Memani, chief investment officer of fixed income at OppenheimerFunds, which has $222.08 billion in assets under management, said that while recent economic data has been better than expected, the improvement is modest.

"If the Fed wants to keep the markets focused on the 'low for long' rate outlook -- more than the tapering, itself -- it would behoove them not to taper now, but indicate to the market in no uncertain terms that tapering is definitely coming, that it's just a matter of timing," he said.

Supply could remain another source of pressure on the Treasury market.

"Supply is unusually heavy given the constrained holiday calendar and that could put some further pressure on the curve," Lowery said.

In addition to the $35 billion in five-year debt sold on Wednesday, the Treasury will sell $29 billion in seven-year notes and $16 billion in five-year Treasury inflation-protected securities on Thursday.

Benchmark 10-year Treasury notes were down 12/32 in price, their yields rising to 2.88 percent, toward the high end of their recent range.

The 30-year bond price was down 17/32, its yield rising to 3.90 percent.

A Reuters poll last week showed 32 economists forecast the U.S. central bank would act in March, while 22 said it would scale back its $85 billion monthly bond-buying program in January. Twelve economists expected a tapering announcement this week.