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Bond Prices Fall in Profit Taking

Long-dated U.S. Treasury debt prices fell Monday as traders took profits ahead of new supply of government bonds this week, cashing in on a recent rally driven by fears of a U.S. recession.

Treasurys have strengthened since the middle of last year, with the benchmark 10-year note's yield -- which moves inversely to its price -- falling more than 1.5 percentage points. But more investors now reckon the rally is running out of steam even though the Federal Reserve will likely cut benchmark U.S. interest rates again.

"The consensus that is developing is pretty bearish on Treasurys given the trend down we have seen in absolute yield levels," said William Bellamy, director of fixed income, with Thompson, Siegel & Walmsley in Richmond, Va.

Even after the Federal Reserve's cumulative 125 basis points of rate cuts in late January, the fed funds target rate is still about 1 percentage point above the 2-year Treasury note yield, he noted. "People are becoming skeptical about whether it's sustainable," Bellamy said.

As a result and ahead of U.S. government bond issuance this week, investors took profits in Treasurys, traders said.

Benchmark 10-year Treasury notes were trading 13/32 lower in price for a yield of 3.64 percent, from 3.60 percent from late Friday.

Trading volume was quite muted Monday following celebrations in New York City after the New York Giants upset the New England Patriots to win the Super Bowl on Sunday.

The market's weakness was also partly attributed to traders trying to push bond prices down ahead of a new supply of government debt later this week.

"There is a little less interest in longer-term stuff at these yield levels. Another factor is we have 10s and 30s coming into play on Wednesday and Thursday," said Beth Malloy, bond market analyst with research company, Briefing.com in Chicago.

The Treasury will auction $13 billion in 10-year notes on Wednesday and $9 billion in 30-year bonds on Thursday.

Ahead of the auctions, traders were steepening the yield curve, moving to widen the spread of longer-dated bond yields over shorter maturities. The curve, or the spread in yield between 2-year notes and 10-year notes, rose above 158 basis points Monday, the widest level since October 2004.

"The flight to quality is getting a little bit more focused to the shorter end," said Max Bublitz, chief strategist with SCM Advisors in San Francisco.

As worries about the banking sector's exposure to the subprime mortgage debt fallout persist, "people get a little freaked out about risk and gravitate to the front end of the curve," he said.

The 2-year note -- which is very sensitive to expectations for Fed interest rate moves -- was unchanged in price for a yield of 2.07 percent.

Although the economic data calendar is relatively thin this week, it will feature the return of Fed speakers who took a break from the speaking circuit last week in the blackout period surrounding the Fed's January policy meeting.

Among those speaking later in the week will be Dallas Fed President Richard Fisher, who was the lone dissenter in the Fed's Jan. 30 decision to cut the recommended overnight lending rate between banks by a half percentage point.

The Fed cut the fed funds target rate to 3.00 percent last week in an effort to stave off a possible U.S. recession and is widely expected to cut interest rates again at the next policy meeting in March.

Earlier, bond prices were little affected by data showing new orders at U.S. factories rose by a less-than-expected 2.3 percent in December.

Debt traders also largely shrugged off President Bush's fiscal 2009 budget proposal on Monday, which is made up of a $3.1 trillion spending plan that would nearly freeze domestic programs.

Five-year notes were trading 7/32 lower in price for a yield of 2.79 percent from 2.75 percent late on Friday.

The 30-year bond was 1-10/32 lower for a yield of 4.39 percent against 4.31 percent.

The U.S. 10-year interest rate swap spread was unchanged from late Friday at 63.25 basis points.

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