* Prices drop on hopes for deal to avert 'fiscal cliff'
* Treasury sells $25 bln 5-year notes to solid demand
* Treasury will auction $29 bln 7-year notes on Wednesday
* Long bonds hurt as Fed buys only $1.7 bln in buy-back
By Karen Brettell
NEW YORK, Dec 18 U.S. Treasury yields rose to
their highest since October on Tuesday as U.S. President Barack
Obama and Republican lawmakers edged closer to a deal to avert a
fiscal crisis in early 2013.
Negotiations to avoid a "fiscal cliff" of U.S. tax hikes and
spending cuts looked closer to an agreement after House of
Representatives Speaker John Boehner kept the support of his
Republican colleagues for compromises in talks with Obama.
An agreement is likely to reduce demand for safe-haven U.S.
debt and boost riskier assets, including stocks, as fears over
the potential impact on the economy are removed.
"Agreement on the 'fiscal cliff' could bring a significant
move away from safe-haven assets, not just here in the U.S., but
globally," said Dan Heckman, senior fixed income strategist at
U.S. Bank Wealth Management in Minneapolis.
New Treasuries supply is also weighing on prices.
The Treasury sold $35 billion in 5-year notes on Tuesday and
will sell an additional $29 billion in seven-year notes on
Wednesday and $14 billion in five-year Treasury
Inflation-Protected Securities (TIPS) on Thursday.
"We're also seeing some back-up due to heavy supply," said
Tuesday's five-year note sale drew solid demand, selling at
a high yield of 0.769 percent, around half a basis point higher
than where the notes traded before the auction.
Direct bidders took 30.4 percent of the auction, the second-
largest on record, part of a shift over the past few years in
which more investors are buying directly from the government and
"The directs are in many cases matching the indirects," who
buy debt through dealers, said Richard Gilhooly, interest rate
strategist at TD Securities in New York.
Indirect bidders bought 32.4 percent of the sale and dealers
took 37.2 percent.
"Looking at what dealers got I would say it's a strong
auction," Gilhooly said.
Longer-dated bonds were also hurt on Tuesday after the
Federal Reserve bought near the minimum in a buy-back of bonds
as part of its Operation Twist program.
The Fed bought $1.7 billion in bonds due between 2036 and
2042, out of $4.11 billion submitted for purchase.
Traders had been expecting the Fed's purchases would help
support bonds this week.
It will buy between $1.5 billion and $2.25 billion each day
this week and will focus purchases on long bonds due between
2036 and 2042 in both Wednesday and Friday's buy-backs.
Thirty-year bonds fell 1-9/32, their yields
rising to 3.02 percent, the highest since September 17, and up
from 2.95 percent late Monday.
The gap between five-year notes and 30-year bonds expanded
to 225 basis points, out from 221 basis points on Monday, and
the widest since October 9.
Benchmark 10-year notes were down 16/32 in
price, their yields rising to 1.84 percent, the highest since
Oct. 25 and up from 1.77 percent late on Monday.