US yields rise after three-day fall; five-year auction shows solid demand

• US five-year note auction shows strong outcome
• Auction also shows robust foreign investor interest
• Fed to hold two repo operations starting next month

NEW YORK, May 28 (Reuters) - U.S. Treasury yields advanced on Wednesday, after falling for three straight days, as investors consolidated their positions on a day when there was little economic data to drive the market, but they pared their rise after a successful auction of five-year notes.

The sale of $70 billion in U.S. five-year Treasuries showed healthy foreign demand, easing worries about investors potentially shifting from dollar assets due to fiscal sustainability concerns and recent tariff-related volatility.

So-called "indirect bidders," which include foreign central banks, took 78.4% of the auction. "It looks to be a record high for this group and therefore suggests strong foreign interest in this paper," said Lou Brien, market strategist for DRW Trading in Chicago, in emailed comments after the auction.

The sale cleared at 4.071%, lower than the expected rate at the bid deadline, suggesting there was no need to add a premium to the yield as investor appetite for the note was strong.

The bid-to-cover ratio, another measure of demand, was at 2.39 cover, down slightly from last month's cover of 2.41, but in line with the 2.38 average.

"In my view, auction bidders are back regardless of tariffs or new policies going through the U.S. Government," wrote Tom di Galoma, managing director at Mischler Financial in an email after the five-year note sale.

Primary dealers, that usually step in when investor demand is weak, ended up with 9.2%, the second lowest on record, di Galoma said.

In afternoon trading, the yield on the benchmark U.S. 10-year Treasury note US10YT=TWEB was up 4.3 basis points (bps) retreating after the auction from the 4.501% peak during the day. U.S. 30-year yields US30YT=TWEB were last up 3.1 bps at 4.970%, down from their 5% peak on Wednesday.

The minutes from the latest Federal Reserve Open Market Committee meeting, meanwhile, were seen as unsurprising and had little effect on the market. The minutes showed officials acknowledging they could face difficult tradeoffs in coming months, in the form of rising inflation alongside rising unemployment.

"With inflation above target and a low unemployment rate, it’s not shocking that the Fed would think they can afford to wait for more clarity on the economic effects of tariffs," said Brian Jacobsen, chief economist at Annex Wealth Management in Menomonee Falls, Wisconsin.

Jacobsen believes the Fed will take its lead from the markets. "As long as inflation expectations stay contained, they’ll likely view any tariff-induced inflation as fleeting. If yields start rising and it is because inflation expectations are becoming unmoored, then they’ll squawk hawkishly."

The two-year US2YT=TWEB U.S. Treasury yield, which typically moves in step with interest rate expectations, was last up 4.3 bps at 3.992%.

Markets still hope for an interest rate cut in September, with a 58% chance, but the higher certainty, 79%, is for a reduction in the October Fed meeting, according to CME's FedWatch tool.

STANDING REPO FACILITY

The Fed, meanwhile, announced on Wednesday that next month it will add morning offerings for its liquidity providing Standing Repo Facility, known as SRF, to the existing afternoon operations.

Launched in 2021, the facility helps the Fed keep the federal funds rate, its chief tool for influencing the course of the economy, in line with levels targeted by Federal Open Market Committee.

"It is an attempt to make markets more resilient during times of stress by providing borrowers with an opportunity to tap the Fed facility earlier in the day," said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities in New York. The SRF is currently not being used by banks, but in times of stress twice daily operations could help to backstop markets, he added.

On Thursday, the Treasury will again test demand for securities with a $44 billion offering of seven-year notes.

Among Fed officials speaking on Thursday are Richmond Fed President Thomas Barkin, San Francisco Fed President Mary Daly and Chicago Fed President Austan Goolsbee. A second estimate of the first-quarter GDP is expected to show the U.S. economy contracted 0.3% in the period. Among other economic data points are weekly jobless claims and pending home sales in April.