REFILE-TREASURIES-U.S. benchmark yields edge up from 11-month lows

Thu May 29, 2014 3:50pm EDT

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(Corrects spelling of 'plausible' in last bullet point)

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By Richard Leong

NEW YORK, May 29 (Reuters) - U.S. benchmark Treasury yields inched up from 11-month lows on Thursday as data showed the U.S. economy shrank for the first time in three years in the first quarter but did not alter the view of a solid rebound this spring.

The bond market also digested $29 billion of seven-year Treasuries supply, which drew average demand from investors. The last leg of this week's $95 billion in fixed-rate supply was sold at a 2.010 percent yield, the lowest since October.

The downgrade in business activity that resulted in first-quarter gross domestic product falling 1.0 percent stemmed largely from a drop in inventories. While this was steeper than forecast, it was not severe enough to change the outlook for a sizable recovery in the second quarter.

Moreover, a recent bond market rally has lowered yields to levels consistent with this level of growth, analysts said.

"The bond market is priced in for a pretty weak economy already. Everybody knew it was going to be a contraction even though it's a bigger drop than what they had thought. There's not more room for yields to move lower," said Craig Dismuke, chief economic strategist at Vining Sparks in Memphis, Tennessee.

This modest growth outlook might be enough for the Federal Reserve to consider raising rates in the second quarter of next year, Richmond Federal Reserve President Jeffrey Lacker told CNBC television.

The benchmark 10-year U.S. Treasuries yield last traded at 2.447 percent, up 1 basis point from late Wednesday, after touching 2.422 percent, the lowest since last June.

The yield on the 30-year bond was 3.304 percent, up 2 basis points from Wednesday's close. Earlier it hit 3.278 percent, an 11-1/2-month low.

U.S. yields bounced in a tight range on lighter-than-usual volume with some European markets closed for Ascension Day. This suggested a pause in the intense bond demand in recent days.

"It may be time for the market to correct itself and pull back a bit," said Sean Murphy, a Treasuries trader at Societe Generale in New York.

U.S. yields have fallen on economic worries, safe-haven demand tied to conflict in Ukraine and technical factors that include month-end portfolio rebalancing and exiting bets on rising yields.

Traders said foreign investors have scrambled for U.S. bonds because of relatively higher yields compared with German Bunds as they anticipate that the European Central Bank might cut interest rates next week to help the euro-zone economy.

Still, the extent of the bond market's rally has confounded some analysts and investors even as the Standard & Poor's 500 index set a record intraday high for a third straight day. (Reporting by Richard Leong; Editing by James Dalgleish and Jan Paschal)

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