Oct. 24 (Bloomberg) -- Treasury 10-year notes fell for a third week as investors speculated the Federal Reserve may begin to signal an increase in interest rates from historic lows and as the U.S. prepared to auction a record $123 billion of notes. The yield on the two-year security, most sensitive to monetary policy, yesterday rose above 1 percent for the first time this month as Fed Bank of Philadelphia President Charles Plosser on Oct. 22 told Bloomberg Radio his “instinct is the time for raising rates will be before many of my colleagues” think it is. The U.S. economy expanded in the third quarter for the first time since June 2008, a Commerce Department report will show next week as the Fed is scheduled to end its $300 billion Treasury purchase program. “There’s heightened uncertainty on the next move,” said George Goncalves, chief fixed-income rates strategist at Cantor Fitzgerald LP, one of the 18 primary dealers that trade directly with the Fed and are required to bid at Treasury auctions. “The front end of the curve is becoming more volatile. Supply next week will be a test of that.” The 10-year note yield rose eight basis points on the week, or 0.08 percentage point, to 3.49 percent, according to BGCantor Market Data. The 3.625 percent security maturing in August 2019 fell 20/32, or $6.25 per $1,000 face amount, to 101 1/8. Record Supply The yield on the two-year note rose five basis points on the week to 1.01 percent. Investors have driven the difference between 2- and 10- year yields to 2.46 percentage points, widening the gap for a fourth week. The figure compares to an average spread of 88 basis points over the past five years. Gross domestic product grew 3.2 percent from July through September, according to the median estimate of 65 economists in a Bloomberg News survey. The economy contracted 0.7 percent in the previous quarter, less than anticipated. The U.S. will sell $7 billion in five-year Treasury Inflation Protected Securities on Oct. 26, $44 billion of two- year notes on Oct. 27, $41 billion of five-year notes on Oct. 28 and $31 billion of seven-year securities on Oct. 29. “The onslaught of new issue supply” is weighing on the Treasury market, Kevin Giddis, head of fixed-income sales, trading and research at the brokerage Morgan Keegan Inc. in Memphis, Tennessee, wrote in a note to clients yesterday. The previous record for notes sold in a week was $115 billion over the five days ended July 31, when the Treasury sold $6 billion in 20-year TIPS, $42 billion in 2-year notes, $39 billion in 5-year securities, and $28 billion in notes maturing in seven years. ‘Tools in Place’ The Treasury will also sell $30 billion in six-month bills and $29 in three-month bills on Oct. 26. The Fed is scheduled on Oct. 29 to complete the $300 billion Treasury purchase program it began in March, part of its effort to cap consumer borrowing costs. Ten-year note yields fell 47 basis points, the most since 1962, to 2.53 percent when the central bank announced the program on March 18. The yield since then rose as high as 4 percent, in June, amid concern Treasury supply would overwhelm demand as the economy showed signs of recovery, and touched as low as 3.10 percent in October as economic reports suggested the recovery would be slow. The central bank said in a statement on Oct. 19 it is working with counterparties to test a system to withdraw the unprecedented amount of cash injected into the financial system the last two years. “The Fed is making sure they have the tools in place when and if they go to implement the exit strategy, but it’s not a signal that it’s any time soon,” said Michael Pond, interest- rate strategist in New York at primary dealer Barclays Plc. ‘Very Creative’ Futures on the Chicago Board of Trade show a 58 percent chance the Fed will boost its target rate for overnight lending between banks by April, compared with 55 percent on Oct. 22. The Fed cut its benchmark rate to a range of zero to 0.25 percent at the end of 2008. “Speculation on a change in the Fed’s policy and if they will raise rates sooner is weighing on the front end,” said Christian Cooper, an interest-rate strategist at primary dealer RBC Capital Markets in New York. “The Fed is still nowhere near raising rates, though. The Fed was very creative when adding liquidity to the market and they will be just as creative drawing out the liquidity.” At their most recent meeting, on Sept. 23, members of the Fed’s policy-making Open Market Committee kept the benchmark rate in a range of zero to 0.25 percent. In a statement, they said economic conditions will warrant keeping the rate low “for an extended period.” The central bank said its 12 district banks saw “stabilization or modest improvements” in many areas of the economy, with “little or no ” price pressures. The comments came in its Beige Book survey published Oct. 21, two weeks before officials meet to set monetary policy. To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net.

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