A $30 billion sale of two-year Treasuries today will result inthe highest yield in three years, according to pre-auction trading,amid speculation the Federal Reserve is moving closer to raisinginterest rates.

A gauge of expectations for consumer prices during the next 10years was near the most in five months before Fed officials speakthis week, with markets indicating a 59 percent chance they willboost interest rates by July of next year. Economists say a reporton Thursday will show the central bank's preferred measure ofinflation—the personal consumption expenditures (PCE) priceindex—rose to the highest since October 2012. The U.S. is selling$107 billion of coupon-bearing debt this week.

“The auctions this week are going to add pressure to the frontend of the curve,” said Shirley Tsai, a bond trader at Hontai LifeInsurance Co. in Taipei “This week, the core PCE is going to bereleased, and we expect this data to go higher. We also expect the10-year break-even rate to go higher gradually.”

The benchmark 10-year yield was little changed at 2.62 percentat 6:40 a.m. in London, according to Bloomberg Bond Trader data.The price of the 2.5 percent note maturing in May 2024 was 9831/32. The yield has increased from 2.48 percent at the end of lastmonth.

Treasury trading volume fell to $192 billion yesterday, thelowest level since May 23 and a third straight daily decline,according to ICAP Plc, the largest inter-dealer broker of U.S.government debt. The average daily volume during the past year is$317 billion.

Two-year notes yielded 0.5 percent in when-issued trading beforetoday's auction, which would be the highest since a sale in May2011 yielded 0.56 percent. The yield on the current two-year notewas little changed today at 0.46 percent.

Investors bid for 3.52 times the amount of notes on offer at theprevious auction on May 27, compared with 3.35 in April. Indirectbidders, the category of investors that includes foreign centralbanks, purchased 18.9 percent, down from 23.4 percent. Directbidders, non-primary-dealer investors that place their bidsdirectly with the Treasury, purchased 25.2 percent.

“Two-year auction performance has weakened slightly recently,”Anshul Pradhan and Vivek Shukla, strategists at Barclays Plc in NewYork, wrote in an e-mailed note dated yesterday. “Both foreigninvestor and domestic investment fund demand has declined recently.Despite this, however, broker-dealer takedown is still higher thanin 2013.”

Looming Supply

The U.S. will sell $35 billion of five-year notes tomorrow and$29 billion of seven-year securities the following day. It willauction $13 billion of two-year floating-rate debt tomorrow.

Japan's 10-year yield was unchanged at 0.58 percent, whileAustralia's dropped five basis points, or 0.05 percentage point, to3.65 percent.

The Fed at its June 17-18 meeting reduced monthly debt purchasesby $10 billion, to $35 billion, while leaving the target rate forovernight lending between banks in a range of zero to 0.25 percent,where it has been since December 2008.

There's a 59 percent chance the Fed will raise its benchmarkrate to at least 0.5 percent by July of next year, based on Fedfunds futures yesterday, compared with a 43 percent probability atthe end of last month.

The 10-year break-even rate, which measures the differencebetween yields on benchmark notes and similar-maturity Treasury Inflation Protected Securities, widened to 2.28percentage points yesterday, the most since Jan. 13. The gauge,which represents the bond market's forecast for the pace ofconsumer-price increases, has climbed from 2.21 at the end ofMay.

The Fed's 2 percent annual inflation goal is based on the PCEprice index. The gauge increased to 1.8 percent last month, versus1.6 percent in April, according to a Bloomberg News survey beforethis week's report.

Philadelphia Fed President Charles Plosser will speak today inNew York on the economic outlook and the monetary policy. New YorkFed President William Dudley also speaks today.

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