TREASURIES-Yields rise in anticipation of Treasury auction

(Adds details of Treasury auctions in paragraph 8, comment in paragraphs 6-7, 12-13, updates prices at 3:25 p.m. ET (2025 GMT)

By Herbert Lash

NEW YORK, Feb 26 (Reuters) -

U.S. Treasury yields rose on Monday as investors sought a higher premium for taking on a record $127 billion in government coupon debt at two auctions that suggested demand was a bit weak ahead of key inflation data later in the week.

Yields early in the session were mostly lower but edged higher in anticipation of the first sale of $63 billion in two-year Treasury notes and 90 minutes later the sale of $64 billion in five-year Treasury notes.

After the auctions the inversion of the yield curve between the two-year note, which reflects interest rate expectations, and the 10-year note steepened as the shorter-duration bond's yield rose more than that of the benchmark's.

The auctions, in addition to $42 billion of seven-year notes on Tuesday, come before the much-anticipated release on Thursday of January's personal consumption expenditures price index (PCE)- the Federal Reserve's preferred inflation gauge.

The consumer price index for January two weeks ago showed inflation increased at an annualized 3.1%, or more than market expectations of 2.9% and still above the Fed's target of 2%.

"If investors are just sitting here saying, ‘Well, maybe I'm not so sure about 2% inflation,’ then you're not going to have as much demand" for bonds, said Steven Ricchiuto, U.S. chief economist at Mizuho Securities USA LLC in New York.

"We're slightly through the upper end of the fair value trading range. Assuming you think inflation is going to be 2%, the fair value trading range should be 3.75% to 4.25%," he said, referring to the yield on benchmark 10-year Treasury notes.

The two-year notes were sold at a high-yield of 4.691%, and five-year notes were sold at a high-yield of 4.320%. The bid-to-cover ration was 2.49 and 2.41, respectively.

The two-year's yield was

up 3.5 basis points

at

4.725

%, close to a three-month high of 4.759% on Friday. The yield on 10-year notes

rose 2.1 basis points

to

4.282

%.

The yield curve of the two bonds was at

-44.5

basis points, indicating the two-year's yield is higher than the 10-year note, which is unusual because longer-term debt should pay more to account for the increased risk of holding it.

Investors, the same as the Fed, await a new batch of data to confirm whether the economy is slowly weakening or remains robust as recent jobs data has suggested.

"I do think it's wait and see mode until there's a bit more clarity on whether or not the January data are legit and really show relying surprising strength in the U.S. economy," said Mike Schumacher, head of rates strategy at Wells Fargo in New York.

"Or maybe they were kind of fluky and seasonally distorted."

The market has sharply pulled back expectations on the timing and size of Fed rate cuts this year, which also has pressured yields higher as the U.S. economy remains strong.

Fed funds futures show a 61.1% chance that the Fed starts cutting rates in June, with a 38.8% probability of no cut at all, a sharp reversal from bets on Feb. 1 of a 62% chance of a cut in March, according to CME Group's FedWatch Tool.

Futures traders also are betting on about 79 basis points of cuts by December, about half the amount they anticipated at the end of last year.

Yields also rose after data showed sales of new U.S. single-family homes rose less than expected in January, even as demand for new construction remains underpinned by a persistent shortage of previously owned homes.

New home sales increased 1.5% to a seasonally adjusted annual rate of 661,000 units last month, the Commerce Department's Census Bureau said on Monday.

The yield on the 30-year Treasury bond rose 2.1 basis points to 4.401%.

The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) was last at 2.424%.

The 10-year TIPS breakeven rate was last at 2.315%, indicating the market sees inflation averaging about 2.3% a year for the next decade. (Reporting by Herbert Lash; Editing by Andrea Ricci and Marguerita Choy)