By Wes Goodman Feb. 23 (Bloomberg) -- Treasuries snapped a decline before industry reports that economists said will show U.S. consumer confidence fell and housing prices dropped for a 36th month. Yields indicate investors are cutting back on inflation expectations after a government report last week showed consumer prices excluding food and energy declined in January. The data bolstered speculation the Federal Reserve will refrain from raising interest rates in coming months as it seeks to foster the economic revival. The U.S. is scheduled to sell $44 billion of two-year notes today, the second of four auctions this week totaling a record $126 billion. “There is room for yields to go down,” said Yasutoshi Nagai, chief economist at Daiwa Securities Capital Markets Co., part of Japan’s second-largest brokerage. “There is some possibility that deflation will continue.” The 10-year note yielded 3.79 percent as of 2:11 p.m. in Tokyo, according to data compiled by Bloomberg. The 3.625 percent security due February 2020 traded at 98 21/32. The yield climbed two basis points yesterday, approaching a six-week high. Ten-year yields may decline to 3.60 percent this week, Nagai said. Consumer sentiment dropped in February for the first time since October, according to a Bloomberg News survey of economists before the New York-based Conference Board reports the figure today. Home prices in the U.S. declined 3.1 percent in December from November, a separate report may show. Inflation Outlook The difference between yields on 10-year notes and Treasury Inflation Protected Securities, or TIPS, a gauge of trader expectations for consumer prices, narrowed for a third day to 2.25 percentage points. The consumer price index rose 0.2 percent in January, and fell 0.1 percent when excluding food and energy, the Labor Department said Feb. 19. The core inflation rate increased 1.6 percent in the past 12 months, below the average of 2.7 percent since the start of the 1990s. “Core disinflation lives,” Ed McKelvey, senior U.S. economist for Goldman Sachs Group Inc. in New York, wrote in a report yesterday. “We continue to expect year-to-year core CPI inflation to recede during 2010.” Goldman is one of the 18 primary dealers that underwrite the U.S. debt. Bond investors track these figures because increases in the cost of living erode the value of the fixed payments from debt. Disinflation is a slowing of inflation. Below Potential Two-year notes rose for a second day yesterday as Fed Bank of San Francisco President Janet Yellen said the U.S. economy will operate below potential this year and next. Now is “not the time to be tightening monetary policy,” Yellen said in a speech in San Diego. The Fed will leave its target for overnight lending in a range of zero to 0.25 percent through June and raise it to 0.50 percent in the third quarter, according to a Bloomberg survey of banks and securities companies, with the most recent forecasts given the heaviest weightings. Fed Chairman Ben S. Bernanke is scheduled to testify before congressional panels tomorrow and the next day. The government plans to sell $44 billion of two-year debt today. It will auction, $42 billion in five-year notes tomorrow and $32 billion of seven-year debt Feb. 25. It sold $8 billion in 30-year Treasury Inflation Protected Securities yesterday. Two-year notes yielded 0.94 percent in pre-auction trading, climbing from 0.88 percent at the prior sale of the securities on Jan. 26. Investors bid for 3.13 times the amount on offer at the previous auction, compared with an average of 3.03 for the past 10 sales. Auction Result Indirect bidders, the category of investors that includes foreign central banks, purchased 43.1 percent of the notes, versus the 10-sale average of 44.6 percent. Two-year notes have returned 0.7 percent this year, versus a 0.8 percent loss for 30-year bonds, according to indexes compiled by Bank of America Corp.’s Merrill Lynch unit. The sale of 30-year TIPS drew a yield of 2.229 percent. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of bonds offered, was 2.45. The bidding result “does not scream an A-plus auction,” Dan Greenhaus, chief economic strategist at Miller Tabak & Co. in New York, wrote in a note to clients. “There has been a clear removal of inflationary concerns from the marketplace over the last few trading days and weeks.” The difference between two- and 10-year yields was 2.90 percentage points, close to the high of 2.94 percentage points set Feb. 18. Two-year yields, which follow what the Fed does with its target for overnight lending because of their short maturities, attracted investors betting the central bank will keep its benchmark rate at a record low to spur the economy. Money managers demanded a premium to buy longer-term securities as the Treasury Department holds this week’s record debt sales. “People are more confident that a rate hike is not coming soon,” said Tomohisa Fujiki, an interest-rate strategist at BNP Paribas Securities Japan Ltd. in Tokyo. “Investors are buying short-term bonds. Supply concern is sending longer-term yields higher.” BNP is another primary dealer. To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.

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