AM check: risk-on, risk off, Two-Year Swap Spread ,10-year swap

(Updates to add swap spreads and price table.)

By Min Zeng Of DOW JONES NEWSWIRES NEW YORK (Dow Jones)--Prices of Treasury securities fell Thursday as better-than-forecast global data and strong U.S. corporate earnings spurred a strong rally in the stock market, reducing demand for safe assets.

The two-year note's yield rose from the record low of 0.545% hit overnight while the benchmark 10-year note's yield bounced up off a 15-month low. Long-dated securities bore the bulk of the selling, reversing Wednesday's gains.

"It is a risk-on day, so Treasurys pay the price," said Ward McCarthy, chief financial economist within the fixed income group at Jefferies & Co.

As of 3:50 p.m. EDT, the 10-year note was down 13/32 to yield 2.930% and the 30-year bond was 1 2/32 lower to yield 3.951%. The two-year note was little changed at 0.564%. Bond yields move inversely to prices.

Investors' worries for the economic outlook were soothed somewhat by a smaller pace of decline than economists had forecast in reports on U.S. existing home sales and leading indicators. Overnight, reports showed that the euro zone's private sector expanded at a faster pace in July, boosted by an unexpected pickup in the manufacturing and services sectors, while retail sales in the U.K. also beat market expectations.

Strong earning reports from such economic bellwether companies as AT&T Inc. (T), 3M (MMM) and Caterpillar Inc. (CAT) also improved investors' appetites for riskier assets. That eroded flows into the Treasury market which, in recent weeks, had enticed strong demand driven by fears that the economic recovery could falter in the second half of the year.

Ted Ake, head of Treasury and Agency trading in New York at Societe Generale SA, said there was profit-taking in the Treasury market in front of next week's supply.

The Treasury Department announced Thursday that it will sell $104 billion in new notes next week, including $38 billion in two-year notes, $37 billion in five-year notes and $29 billion in seven-year notes. The amount of two-year notes was down by $2 billion from June's auction, while the sizes for the five-year and seven-year notes were reduced by $1 billion each, respectively.

Treasury prices had rallied Wednesday following comments by Federal Reserve Chairman Ben Bernanke, during his semiannual testimony to Congress, that the economic outlook is "unusually uncertain." The remark fed into speculation among market participants that key interest rates will stay low well through 2011. The yield on the 10-year note, the benchmark for consumer and corporate borrowings, hit 2.851% Wednesday, the lowest level since April 21, 2009.

Bernanke reiterated in a second day of congressional testimony Thursday that he is prepared to take further action to support the economy if the outlook deteriorates, but indicated the Fed's reluctance to do so, given limited options and questions about the effectiveness of any new measures.

Bond yields have dropped sharply in recent months, pushing down the 10-year note's yield from this year's peak of 4.017% in early April. The market initially rallied as euro-zone debt problems flared up but, over the past few weeks, the main driver has become worries about the U.S. economic outlook.

James DeMasi, chief fixed-income strategist at the Baltimore unit of Stifel Nicolaus & Co., said the Treasury rally is "extremely overdone." DeMasi said the 10-year note's yield trading below 3% isn't justified by the economic fundamentals as he doesn't expect another downturn in the economy, even though the recovery is slow.

With no U.S. data expected Friday, the market's focus is likely to be on the release of the stress test results for euro-zone banks, scheduled for 1600 GMT, after European markets have closed. The test is a main gauge on the health of the region's banking system and the results could shape investors' risk appetites for the coming days and weeks.

Marco Annunziata, chief economist at UniCredit Group, said that given the recalcitrant and rather secretive way in which it has been prepared, the release is unlikely to be "the silver bullet" that guarantees a rapid normalization of the financial system.

Still, Annunziata said, "positive surprises might come if individual national regulators outperform in terms of transparency, and governments quickly follow up to address the exposed pockets of weakness."

Two-Year Swap Spread Tightens The two-year U.S. swap spread, a main gauge of credit risks, was 1.5 basis points tighter at 21.75 basis points. The 10-year swap spread was 1.25 basis point tighter at 0.25 basis points.

The 10-year swap spread, which measures the extra 10-year swap rate over Treasury yield, approached zero again in recent sessions as demand picked up speed for swaps from companies to exchange fixed-interest payments for floating payments.

With the Fed pledging to keep rates low for an extended period, quite a few companies have taken advantage of the low-rate environment to sell new debt. They used the swap markets to hedge against undesired volatility of interest rates or to reduce debt payments.

In March, surging demand on swaps pushed the 10-year swap spread to turn negative for the first time on record.