UPDATE 2-US sells $35 bln in notes as debt deadline looms
* 2-yr auction results overcome U.S. debt default jitters
* Foreign demand still weak at U.S. 2-yr auction
* Investment funds again show strong buying interest (Adds background, context, details)
NEW YORK, July 26 (Reuters) - The U.S. Treasury sold $35 billion worth of two-year notes on Tuesday in an auction that managed to overcome worries over the government's Aug. 2 deadline to raise the debt limit.
The results appeared solid considering the uncertainty clouding the bond market as Washington's showdown over raising the debt limit grows more contentious, though foreign demand remained at a low ebb.
It also suggests that some investors, at least, see nowhere to run even if the United States were to default or if political paralysis results in a downgrade of U.S. debt by credit ratings agencies. [ID:nN1E76P12Q]
"Somehow it seems like Treasuries have become insurance against their own downgrade. At least that's how it appears from the market behavior," said Thomas Simons, money market economist at Jefferies & Co in New York.
"This auction went pretty well. There was nothing particularly interesting about the statistics, but in the context of the current debt ceiling issues, the bid was aggressive."
The bond market showed little reaction to the auction and maintained the day's earlier gains. The benchmark 10-year note US10YT=RR was last trading 14/32 higher in price on the day, yielding 2.95 percent.
The sale, the first of this week's three note offerings totaling $99 billion, attracted bids worth 3.14 times the amount on offer. That was up from last month's auction, which was poorly received, but below the six-month average of 3.21.
The next sales are a $35 billion auction of five-year notes on Wednesday and Thursday's $29 billion offering of seven-year debt.
In one sign of strength, yields at Tuesday's auction came in below expectations, based on trading in the when-issued market at the 1 p.m. deadline for bids, which indicates investors were not demanding an above-market premium.
However, a measure of foreign demand, indirect bids, came in below average, suggesting foreign investors might be taking a skeptical view of the market given the contentious debate over the U.S. national debt.
President Barack Obama's Democrats and their Republican rivals headed for a showdown over competing debt plans one week before a deadline for averting a potentially disastrous U.S. default. [ID:nN1E76P002]
Indirect bids accounted for about 28 percent of the sale, which is below their six-month average of 30 percent.
One key support was the direct bidder category, which includes investment funds. This group showed strong interest, helping the auction overall look reasonably solid.
"Given the veil of uncertainty that hangs over the Treasury market, we see this auction as a very good result," said William O'Donnell, head of Treasury strategy at RBS Securities in Stamford, Connecticut.
"Indirect bidder participation was below average again but direct bidder participation was strong and allowed this auction to come pretty much on the screws."
Direct bidders took 20 percent of the offering, well-above their six-auction average of 13.5 percent. (Additional reporting by Ellen Freilich; Editing by Neil Stempleman)
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