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NEW YORK, Feb 22 (Reuters) - The U.S. bond market held up against a $258 billion deluge of Treasury debt supply, the second largest weekly amount ever, as the government sought to raise more cash to fund an expected jump in its budget deficit.
The hole in the federal budget is projected to grow due to last year's major tax overhaul that is estimated to add up to $1.5 trillion to the government indebtedness in a decade.
A two-year federal budget deal reached earlier this month is also forecast to add $300 billion in military and domestic outlays.
Wall Street and investors took down with relative ease this week's flood of government bond supply that included record amounts of three-month and six-month T-bills.
But that came at a cost.
The Treasury Department paid the highest interest rates in more than nine years to dealers and investors to buy its short-term debt.
The Treasury is expected to crank up its bond issuance in the coming months to meet its budget needs, while investors and traders will likely demand more compensation to buy them, analysts said.
"The market-clearing (yields) will go higher," said Praveen Korapaty, head of U.S. rates at Credit Suisse in New York. "Come later this year, the cumulative funding gap will really explode."
Rising Treasury supply is coming at a time when investors and traders are rattled by evidence of rising inflation and concerns the Federal Reserve may raise interest rates faster to keep the economy from overheating.
The Federal Open Market Committee, the Fed's policy-setting group, showed more confidence in the need for further rate hikes as most policymakers believed inflation would perk up toward their 2 percent goal, according to minutes on a Jan. 30-31 meeting released on Wednesday.
Benchmark 10-year Treasury yields reached 2.957 percent, a four-year peak, shortly after the release of the FOMC minutes.
"The Treasury market wants to trade bearishly," said Ian Lyngen, head of U.S. interest rates strategy at BMO Capital Markets in New York.
On Thursday, the Treasury offered $29 billion in seven-year government notes, the last leg of this week's supply. The latest seven-year issue was sold at a yield of 2.839 percent, which was the highest yield in almost seven years, Treasury data showed.
There will be a pullback in supply next week. The government will auction $51 billion of three-month bills, $45 billion in six-month bills and $22 billion in one-year bills.
The Treasury is scheduled to announce the size of the one-month bill auction on Monday.
(Reporting by Richard Leong; Editing by Meredith Mazzilli)