TREASURIES-Edge lower in Asia as regional stocks rally

By Satomi Noguchi

TOKYO, May 29 (Reuters) - U.S. Treasuries edged lower in Asia on Thursday as regional stocks rallied and investors cautiously awaited another debt auction later in the day that could further dent market sentiment.

Treasuries extended sharp losses made on Wednesday when higher oil prices fanned inflation fears and stronger-than-expected data on durable goods soothed recession worries.

The yield on the two-year Treasury notes rose to highs not seen since early January ahead of revised growth data that could support the view that the Federal Reserve will hold interest rates steady in the near future and may raise them later this year.

"Thursday's auction of five-year Treasury notes could add to the market's nerves," said a senior manager of the investment group at a Japanese trust bank.

A poor reception to the Treasury's auction of new two-year notes on Wednesday kept investors cautious about a further drop in the market before Thursday's auction of $19 billion in five-year notes.

Dallas Fed President Richard Fisher said late Wednesday that the U.S. central bank would likely increase interest rates "sooner rather than later" if inflation worsens, even if the economy remains weak. He also said the U.S. is in for a spell of "anemic" economic growth but probably not a recession. [ID:nN28352973]

Although Fisher is one of the Fed's leading policy hawks, his remarks followed other U.S. central bank officials who have stepped up their rhetoric on inflation amid surging energy and food prices.

The benchmark 10-year note fell 5/32 in price to yield 4.017 percent US10YTN=RR, up 2 basis points from late New York trade on Wednesday.

The 10-year yield has risen above 4 percent to its highest since the start of the year, and investors expect it to hug a new near-term range near this level before major economic data due out next week.

But in the longer term, persistent price pressures threaten to push the yield steeply higher, investors said.

The new two-year notes auctioned on Wednesday edged down 1/32 in price to yield 2.682 percent US2YTN=RR, up about 7 basis points compared with the yield of the previous benchmark two-year notes around 2.61 percent in late U.S. trade.

The yield of the new two-year notes rose as high as 2.689 percent at one point, the highest since Jan. 11.

The senior manager from the Japanese trust bank said many market players had created positions betting on a steepening in the yield curve against a backdrop of inflation worries.

But these positions are in bad shape as the yields of shorter-dated maturities have been rising faster than those of longer-dated bonds in recent sessions, flattening the curve instead, he said.

The yield curve flattened in Asia on Thursday, with the two-year/10-year yield spread narrowing to 134 basis points, the lowest in around four months.

The Nikkei share average .N225 jumped 3 percent in afternoon trade with stocks in South Korea climbing nearly 2 percent. (Editing by Chris Gallagher)