By Ellen Freilich
NEW YORK, Dec 18 (Reuters) - U.S. Treasury yields on Tuesday rose to their highest since October as U.S. President Barack Obama and Republican lawmakers edged closer to a deal to avert a fiscal crisis in early 2013.
Year-end supply and profit-taking also kept upward pressure on yields, strategists said.
However, prospects for accommodative Federal Reserve monetary policy next year and beyond would limit how much U.S. Treasury yields would rise, they said.
U.S. House Speaker John Boehner said a bill to keep taxes from rising would likely be on the House floor this week.
Progress in the fiscal talks would allow the United States to avoid some 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, austerity 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.
“Agreement on the fiscal cliff could bring a significant move away from safe-haven assets, not just here in the U.S., but globally, in Germany, which is another safe-haven asset,” said Dan Heckman, senior fixed income strategist at U.S. Bank Wealth Management in Minneapolis.
“We’re also seeing some backup due to heavy supply,” he said. “This gets very seasonal with auctions that come in here at the end of the year. We have $113 billion in issuance, including the two-year notes Monday and five-year notes today.”
Heckman said some “pure profit-taking” is playing a role in lifting yields to their highest level in nearly two months.
“Capital gains taxes could be going up a little next year so for investors participating in a 30-year bull market in bonds, if they’re ever going to realize some gains, now is the time to do it,” he said.
Benchmark 10-year notes were down 10/32, their yields rising to 1.81 percent from 1.78 percent late on Monday.
Thirty-year yields were down 27/32, their yields rising to 2.99 percent from 2.97 percent late Monday.
Still, the U.S. Treasury market has been range-bound during the debt talks and Heckman said after a slight rise going into year-end, 10-year yields would likely move between 1.50 percent and 1.80 percent in the coming year.
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).
Cantor Fitzgerald Treasury strategist Justin Lederer said the auction “should go OK” as buyers step in to take advantage of the recent rise in yields.
In addition, “the still vast uncertainties in Washington” would support the safe-haven bid, he said.
Expectations of low rates into 2015 and more quantitative easing set to start in January “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 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.
The prospect 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.”