By Daniel Kruger March 24 (Bloomberg) -- Treasuries fell before a record- tying $42 billion auction of five-year notes as orders for durable goods rose in February for a third month. The five-year note’s yield increased to a two-month high after yesterday’s auction of two-year debt drew the lowest demand since December. The 10-year U.S. swap spread was negative for a second day on rising demand for riskier assets such as corporate and emerging-market securities. “When swap spreads have gone negative, we’ve seen some of the exotics desks have to hedge their positions by selling Treasuries,” said Martin Mitchell, head government bond trader at the Baltimore unit of Stifel Nicolaus & Co., a St. Louis- based brokerage firm. The yield on the current five-year note increased 6 basis points, or 0.06 percentage point, to 2.49 percent at 10:04 a.m. in New York, according to BGCantor Market Data. The price of the 2.375 percent security due in February 2015 fell 9/32, or $2.81 per $1,000 face amount, to 99 15/32. The 5-year note’s yield earlier reached 2.51 percent, the highest level since Jan. 14. The yield on the 10-year note rose as much as 10 basis points to 3.79 percent, the highest level since Feb. 23. The 10-year U.S. swap spread turned negative for the first time on record yesterday. The gap between the rate to exchange floating- for fixed-interest payments and comparable maturity Treasury yields for 10 years shrank to negative 6 basis points today, the narrowest since at least 1988, when Bloomberg began collecting the data. Durable Goods Orders for long-lasting goods increased 0.5 percent in February after a 3.9 percent gain in the previous month, the Commerce Department reported today. Excluding transportation equipment, orders advanced 0.9 percent, more than the median forecast of 45 economists in a Bloomberg News survey. Short-term borrowing costs climbed as traders added to bets the economic expansion will prompt the Federal Reserve to raise rates from a record low zero to 0.25 percent this year or next. The London interbank offered rate that banks charge each other to borrow in dollars for three months climbed to 0.28491 percent today, the highest level in about five months. Interest-rate futures on the CME Group Inc. exchange show a 48 percent chance the Fed will raise the zero to 0.25 percent target rate for overnight lending between banks by at least a quarter-percentage point by September, up from 36 percent odds a month ago. Yellen on Rates San Francisco Fed President Janet Yellen said in a speech in Los Angeles yesterday that while it’s too soon to raise interest rates now, policy makers will be ready to do so “when the time has come.” The central bank’s pledge to keep rates low for “an extended period” is “appropriate,” and the Fed has made “no particular time commitment,” she said. Yellen discounted concern record budget deficits might fuel inflation. “The Fed has to be ready to take away the punch bowl when it’s necessary,” Yellen told reporters after the speech. “When the time has come, am I going to support raising interest rates? You bet. I don’t want to see inflation pick up.” At yesterday’s record-tying $44 billion two-year note auction, investors bid for 3 times the amount on offer, the lowest since December’s sale. The average bid-to-cover ratio for the past 10 auctions was 3.10. Indirect bidders, the category of investors that includes foreign central banks, purchased 34.8 percent of the notes, matching the level in December. The auction drew a yield of 1 percent, higher than 0.996 percent in pre-auction trading. Five-year notes yielded 2.547 percent in pre-auction trading, up from 2.395 percent at the prior sale of the securities on Feb. 24. Investors bid for 2.75 times the amount on offer last month, compared with an average of 2.53 at the past 10 auctions. The government will auction a record-tying $32 billion of seven-year notes tomorrow. To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net

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