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TREASURIES-Yields rise on healthcare hopes, before Fed

* Treasury to sell $26 bln in two-year notes

* Fed meeting statement on Wednesday in focus

* Three-month T-bill yields rise on debt ceiling fears

NEW YORK, July 25 (Reuters) - U.S. Treasury yields rose on Tuesday as expectations that legislators in Washington may pass a healthcare overhaul and rising stocks reduced demand for safe-haven U.S. bonds. Senator John McCain will return to the U.S. Capitol on Tuesday to play what could be a crucial role in salvaging Republican efforts to repeal Obamacare and keep their years-long pledge to unwind the 2010 healthcare overhaul. Investors have been concerned that the failure to pass healthcare legislation reflects discord that will also make budget negotiations acrimonious, raising the risks that debt payments due in October may be delayed as the United States bumps up against the debt ceiling. Investors are also waiting on Wednesday's Federal Reserve statement for new indications about when the U.S. central bank will begin paring its bond holdings and next raise interest rates. The initial selloff I believe had to do with Washington and healthcare and the Fed meeting tomorrow, people lightening up positions, said Charles Comiskey, head of Treasuries trading at Bank of Nova Scotia in New York. Bond weakness accelerated early on Tuesday morning with no obvious catalyst.

Benchmark 10-year notes were last down 13/32 in

price to yield 2.30 percent, up from 2.25 percent on Monday. The S&P 500 and Dow both rose on Tuesday, helped by strong earnings from Caterpillar and McDonald's. Many analysts and investors expect the Fed to announce that it will begin reducing its bond portfolio at its September meeting, but will be watching for any hints on the timing at this weeks meeting. Further interest rate hikes are not seen as likely until at least December. Futures traders are pricing in a 53 percent chance that the Fed will raise rates at its December meeting, according to the CME Groups FedWatch Tool. The Treasury Department will sell $26 billion in two-year notes on Tuesday, the first sale of $88 billion in coupon-bearing supply this week. The U.S. will also sell $34 billion in five-year notes on Wednesday and $28 billion in seven-year notes on Thursday.

Yields on three-month Treasury bills rose to

almost 10-year highs on Tuesday after the Treasury Department on Monday saw tepid demand for a $39 billion auction of the bills. The Congressional Budget Office said last month that Congress would need to increase the debt limit by early to mid-October to avoid a default.

Yields on Treasury bills that mature on Oct. 26

rose to 1.20 percent, the highest level since October 2008.

(Editing by Meredith Mazzilli)

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