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* Two-year yields hit 3-month highs, 10-year yields close
* Durable goods orders grew more than forecast in November
* Nov new homes sales dipped, prior months revised higher
* U.S. bond trading ends early, to close Christmas Day
NEW YORK, Dec 24 (Reuters) - U.S. Treasuries prices fell on Tuesday with benchmark yields hovering near three-month highs as investors trimmed their bond holdings ahead of a shortened session before Christmas. The bond market closed at 2 p.m. EST (1900 GMT) on Tuesday, and will be closed Wednesday as well. Worries over when the Federal Reserve might raise short-term interest rates after it stops buying bonds have bogged down the market, especially among medium-term issues. A stronger-than-expected report on durable goods orders supported the view the U.S. economy might be gathering some momentum into early 2014, raising the risk the U.S. central bank would accelerate its reduction of bond purchases. The news durables goods rose 3.5 percent last month spurred selling in longer-dated Treasuries, which the Fed has targeted to hold down mortgage rates and other long-term borrowing costs to stimulate the economy. "The path of least resistance right now is lower bond prices and higher yields," said John Brady, managing director of interest rate futures sales at R.J. O'Brien and Associates in Chicago.
On light trading volume, benchmark 10-year Treasury notes fell 14/32 in price to yield 2.985 percent, up 45.5 basis points from late on Monday. The 10-year yield was 2.5 basis points short of the two-year high set in September. The yield on two-year notes hit a three-month high of 0.403 percent. Thirty-year bonds declined 25/32 in price, yielding 3.895 percent, up 5 basis points from late on Monday. The yield gap between five-year and 30-year Treasuries, which is seen as gauge of traders' view on changes in the Fed's interest rate policy and its bond purchase program, held for a third straight session near 2.15 percent, which was its tightest level since September. A sharp narrowing of the yield differences between medium- and long-dated Treasuries since last week signaled a combination of worries about a rate increase not too long after the Fed ends its purchase program and doubts about the Fed's communication as an effective policy tool. The Fed said last Wednesday it will pare its monthly purchases of Treasuries and mortgage-backed securities in January by $10 billion to $75 billion. It offset the tapering with a commitment to keep short-term rates near zero "well past the time" that the jobless rate falls below 6.5 percent, especially if inflation expectations remain below target - sowing doubt for some. "The market is still adjusting to the Fed making a qualitative change rather than a quantitative change in their policy thresholds, which would have been easier for the market to digest," said Vishal Khanduja, portfolio manager at Calvert Investments in Bethesda, Maryland. The futures market continued to signal traders' anxiety about the Fed possibly raising policy rates earlier than suggested in the Dec. 18 statement. Federal funds futures implied traders are pricing in a 56 percent chance of a rate rise in June 2015, up from 54 percent on Monday and 39 percent a month ago, according to CME Group's FedWatch, which computes traders' expectations of the fed funds rate that the Fed influences through monetary policy. The rise in bond yields has raised home finance costs, reducing mortgage activity in the latest week. The Mortgage Bankers Association said on Tuesday its index on weekly application activity fell 6.3 percent to the lowest level in 13 years as the average interest rate on 30-year mortgages edged up to its highest level in three months.
The housing recovery was disrupted by a jump in mortgage rates this past summer, but it has shown signs of regaining footing in recent months. New home sales slowed to an annualized pace of 464,000 in November from an upwardly revised 474,000 pace in October, which was the strongest since July 2008.
(Reporting by Richard Leong; Editing by Theodore d'Afflisio and Krista Hughes)