Treasury prices extended gains, lowering yields on 10yr notes by the most in 2 months, after the government received strong demand from investors at its auction of 2yr notes, especially from a group that includes overseas central banks.

Bonds had been higher before the auction after a report showed U.S. consumer confidence dropped much more than expected, increasing the investment appeal of fixed-income assets as investors questioned the ability of the economy to recover.

Yields on the 10yr notes fell 11bps to 3.69%. Earlier, they fell by the most on a closing basis since Dec. 17. On Monday, yields closed near the highest since Jan. 11. Meanwhile, yields on the current 2yr notes declined 5bps to 0.83%.

The Treasury sold $44B in 2yr notes at a yield of 0.895%, lower than traders expected and an indication of strong investor demand. Bidders offered to buy 3.33 times the amount of debt sold, compared to an average of 3.21 times at the last 4 monthly auctions of the maturity, which were all for the same amount. It was the second-highest so-called bid-to-cover ratio since at least 2008. Indirect bidders bought 53.6%, the highest since July 2009. Direct bidders, a group that includes domestic money managers and that has been growing in recent months, purchased 8.2%, compared to an average of 15.3% of recent sales.

More of the auction going to direct or indirect bidders, as opposed to primary dealers, is deemed good for the government and the market. Primary dealers tend to turn around and sell much of the new purchases, weighing on prices.

The auction comes on the eve of Fed Chairman Bernanke's testimony to Congress. Analysts will be searching for any clarification regarding how the increase that the Fed announced in the discount rate last week fits into the central bank's bigger plan to eventually tighten U.S. monetary policy.

Tuesday's auction followed Monday's lackluster sale of inflation-indexed securities.

 
On Monday, the government sold $8B in 30yr TIPS for the first time in 9yrs. The auction came at a yield higher than traders anticipated, indicating the government had to pay up to get the deal done. However, analysts said that's not unusual for what is basically a new security and said that other ways of measuring demand, the bid-to-cover ratio and amount bought by indirect and direct bidders, were reasonably good. Today, the government will auction $42B in 5yr notes, followed by $32B in 7yr debt the next day.

Bonds gained earlier after the Conference Board's index of consumer confidence sank 11 points in February, down to a reading 46.0 from an upwardly revised 56.5 in January. Economists surveyed by MarketWatch had been looking for a slight month-to-month drop, down to 55.5 points from the previously reported January level of 55.9.

Bonds showed little reaction earlier to the S&P/Case-Shiller home-price index, which showed prices in 20 U.S. cities fell 0.2% in December.

Treasurys gained during European trading hours as a closely-watched measure of German business sentiment slipped. The Ifo Institute reported data that showed its business-sentiment index unexpectedly slipped during February, the first decline in ten months. Also supporting bonds, Bank of England Governor Mervyn King said that the economic recovery is still fragile and that risks to the outlook are still weighted to the downside.