By Susanne Walker June 22 (Bloomberg) -- Treasury 10-year notes advanced for the first time in three days as an industry report showed U.S. sales of existing homes unexpectedly fell in May, adding to concern the economy recovery may be faltering. Yields on two-year note yields declined to almost the lowest level since May on speculation the Federal Reserve will cite evidence of sluggish growth when policy makers meet tomorrow. The Treasury will sell $40 billion of the securities today, $2 billion less than the previous offering. “The environment for Treasuries is positive,” said Sean Murphy, a trader in New York at Societe Generale. “We’re probably rich going into the two-year note auction.” The 10-year note yield dropped three basis points, or 0.03 percentage point, to 3.22 percent at 11:36 a.m. in New York, according to BGCantor Market Data. The price of the 3.5 percent security maturing in May 2020 rose 7/32, or $2.19 per $1,000 face amount, to 102 11/32. Yields on two-year notes were little changed at 0.72 percent after earlier decreasing 1 basis point to 0.70 percent. They reached 0.69 percent on June 17, the lowest since May 25. Purchases of existing houses dropped 2.2 percent in May to a 5.66 million annual pace, the National Association of Realtors reported. The median forecast of 74 economists in a Bloomberg News survey was for a 6 percent increase. “My ‘economic recovery rose’ is losing its petals, and leaving me with some nasty thorns in return for my optimism,” Kevin Giddis, head of fixed-income sales, trading and research at brokerage firm Morgan Keegan Inc. in Memphis, Tennessee, wrote in a note to clients. Fed Rate Outlook The Federal Open Market Committee will hold its target rate for overnight lending between banks at a record low range of zero to 0.25 percent at the end of its two-day meeting tomorrow, according to all of the 96 economists surveyed by Bloomberg News. Policy makers have kept the benchmark at that level since December 2008. The difference in yield between five-year Treasuries and Treasury Inflation Protected Securities indicates investors anticipate an inflation rate of 1.69 percent in the next five years, compared with 2.01 percent on April 28, when policy makers concluded their last meeting on monetary policy. “The FOMC is not going to move, and the language is not going to change because it’s too early for the Fed to even contemplate moving rates,” said Kumar Palghat, who helps manage the equivalent of $1.6 billion at Kapstream Capital in Sydney. “Economic data in the U.S. is mixed, and you still have the European overhang.” Government Auctions The two-year notes being offered today yielded 0.75 percent in pre-auction trading, just below the 0.769 percent record yield at the previous sale May 25. Indirect bidders, an investor class that includes foreign central banks, bought 36 percent of the two-year notes at the $42 billion U.S. sale on May 25, compared with an average of 42 percent over the past 10 sales. Treasuries have returned 4.5 percent this year, Bank of America Merrill Lynch indexes show. The Treasury will also auction $38 billion in five-year notes tomorrow and $30 billion in seven-year securities on June 24. “The auction should be reasonably tightly bid,” said Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London. “Two-year auctions are generally not a great challenge for the market, particularly not in this current environment.” To contact the reporter on this story: Susanne Walker in New York at swalker33@bloomberg.net

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