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TREASURIES-U.S. yields slip as Russia's Ukraine move spurs uncertainty

·3-min read

(Adds details from two-year Treasury auction)

By Herbert Lash

NEW YORK, Feb 22 (Reuters) - A rally in U.S. Treasuries driven by safe-haven buying after Russia ordered troops into breakaway parts of eastern Ukraine, reversed on Tuesday as investors took a more cautious approach amid mounting uncertainty in markets.

Germany froze a new gas pipeline and Britain hit Russian banks and three billionaires close to President Vladimir Putin with sanctions as the West responded to Russia's recognition of the two Ukrainian regions as independent.

The yield on 10-year U.S. Treasury notes fell 0.5 basis points to 1.925%, after an early morning price jump sent yields below 1.85% at one point. Yields move in the opposite direction of bond prices.

The closely watched yield curve measuring the gap between yields on two- and 10-year Treasury notes, seen as an indicator of economic expectations, flattened further and was last at 39.7 basis points.

Any flight to quality that was seen overnight has ceased with the market seeing such an extreme situation as probably a selling opportunity, said Tom di Galoma, managing director at Seaport Global Holdings.

Halfway through the Asian session rates rose on the notion that stocks had oversold on the Ukraine news, he said.

"What is surprising to me is that we seem to be giving a lot of credibility to this situation in Ukraine," di Galoma said.

"I don't think this is a win-win for Russia. With all these sanctions that are coming down, it's not going to help them financially," he said.

The U.S. Treasury sold $52 billion of two-year notes at auction to yield 1.553%. The two-year's yield, which typically moves in step with interest rate expectations, was up 5.4 basis points at 1.526% after the morning rally.

The auction was good but primary dealers bought just 15.6% of the notes offered, or roughly almost half of recent sales and the lowest in many years if not ever, said Lou Brien, market strategist at DRW Trading, in a note.

How Russia's foray into Ukraine plays out is unclear but markets believe in the recovery's strength and inflation's hot hand, said Jim Vogel, interest rate strategist at FTN Financial.

"This morning demonstrates how difficult it is to mount a bond rally in the face of increasing uncertainty around the climate for risk assets," Vogel said.

Markets see rates heading higher, with the Federal Reserve expected to move in March, and central banks in Britain, Canada, Australia and New Zealand looking to do the same to fight inflation.

Money markets are pricing in just a 36.5% probability of a 50-bps rate hike in March, down recently from around 60%.

Inflationary pressures were seen in data that showed U.S. business activity regained speed in February as the drag from the winter surge in COVID-19 infections ebbed, but higher prices for inputs remained a burden amid lingering supply constraints.

IHS Markit's flash U.S. Composite PMI Output Index, which tracks the manufacturing and services sectors, rebounded to a reading of 56.0 this month from 51.1 in January.

U.S. consumer confidence, meanwhile, fell for a second straight month in February, with fewer consumers planning to purchase homes, automobiles and go on vacation over the next six months amid concerns about the short-term outlook.

The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) traded at 2.859%, after closing at 2.83% last Friday.

The 10-year TIPS breakeven rate was last at 2.465%, indicating the market sees inflation averaging about 2.5% a year for the next decade.

The U.S. dollar five-years forward inflation-linked swap , seen by some as a better gauge of inflation expectations due to possible distortions caused by the Fed's quantitative easing, was last at 2.301%. (Reporting by Herbert Lash Editing by Chizu Nomiyama and Lisa Shumaker)

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