TREASURIES-U.S. yields steady on fiscal talks

NEW YORK Tue Dec 18, 2012 9:39am EST

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NEW YORK Dec 18 (Reuters) - U.S. Treasury yields on Tuesday steadied just below their highest levels since October as U.S. lawmakers edged closer to a deal to avert a fiscal crisis in early 2013.

According to a source familiar with the talks, President Barack Obama made a counter-offer to Republicans that included a major change in position on tax hikes for the wealthy and helped narrow the differences between the two sides.

Progress in the talk would allow the United States to avoid tax hikes and spending cuts in the new year, developments that would benefit the economy and deplete the bid for safe-haven U.S. government debt.

A lack of agreement would result in more taxes and spending cuts, an austerity package that would tend to depress economic growth and boost the bid for safe-haven U.S. government debt, leading to higher prices for U.S. Treasuries and lower yields.

"Treasuries opened off their overnight lows when positive news broke about the fiscal cliff," said Justin Lederer, market analyst at Cantor Fitzgerald.

"Volumes were fairly heavy" as yields reached their highest levels in weeks, he said.

U.S. borrowing costs over 10 years were flat at 1.78 percent after rising to 1.796 percent in Asian trading, the highest since Oct. 26. The benchmark 10-year note was down 2/32 in price.

Thirty-year yields were little changed at 2.95 percent, after rising to 2.97 percent overnight, also the highest since late October.

The U.S. Treasury market has been range-bound during the debt talks.

The main feature on the landscape for the U.S. Treasury market on Tuesday is the $35 billion auction of five-year Treasury notes at 1 p.m. (1800 GMT).

Lederer said the auction "should go OK." Buyers will step in to take advantage of the recent rise in yields, he said.

In addition, "the still vast uncertainties in Washington" would support the safe-haven bid.

Expectations of low rates into 2015 and more quantitative easing set to start in January and taking place "in this sector of the curve in Treasuries" would also support the five-year auction, he said.

Lederer said downside risks to the five-year Treasury auction are "apathy in the market" and the rest of the supply set for sale this week: a $29 billion seven-year Treasury note auction on Wednesday and Thursday's $14 billion sale of five-year TIPS (Treasury Inflation-Protected Securities).

With regard to the bond market's potential reaction to agreement on U.S. fiscal matters, traders said any selloff related to that could be limited by investors' general appetite for safe-haven Treasuries as the year draws to an end. That could allow 10-year yields to ease to the low 1.60 percent area at the end of 2012, one trader said.

"If there is a compromise, and there is a deal, the market is going to take that as positive. There will be weakness in fixed income," the trader said. But he added: "I still think the market is going to want to be long Treasuries into the end of the year."

The prosepct of accommodative Fed policy for another one to three years should also restrain any rise in Treasury yields.

Referring to decisions reached at the Fed's most recent policy meeting, Brett Wander, chief investment officer, fixed income at Charles Schwab Investment Management, said the Fed had added more "punch to the bowl" to spike the economy "because the average American is still thirsty.

"The way they will do this is to increase their purchases of Treasury securities outright," he noted. "Previously the Fed has been buying mortgages and then 'Operation Twist' was comprised of both purchases and sales of Treasury securities. Now they're just going to do purchases. That, along with the mortgage purchases, will commence in 2013. So that's a lot of punch."

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