By Min Zeng

Prices of Treasury bonds pulled back Tuesday, hurt by the last round of new government debt offerings in 2016.

The first leg of the supply -- a $26 billion sale of two-year notes -- Tuesday afternoon drew the smallest demand since 2008.

Analysts say it reflects diminished appetites for short-term debt as the Federal Reserve two weeks ago raised interest rates for the first time this year and projected three rate increases during 2017. Yields on short-term Treasury debt are highly sensitive to the Fed's policy outlook.

Trading is thinner than normal due to the holiday season, which may exaggerate part of the price moves, say analysts. This condition, they say, may affect demand for this week's auctions as some investors may stay on the sidelines and wait for the new year to make fresh investment decisions.

Thomas Simons, senior vice president in the Fixed Income Group at Jefferies LLC, said the "mediocre" auction demand is "likely owing to the fact that this is a holiday week and many market participants are out."

The yield on the two-year Treasury note rose to 1.239% in recent trading, near the highest level since 2009, according to Tradeweb, compared with 1.205% Friday. Yields rise as bond prices fall. The bond market was shut Monday for the Christmas holiday.

The yield on the benchmark 10-year Treasury note was 2.571%, near the highest level in more than two years, according to Tradeweb, compared with 2.542% Friday.

Higher stocks and crude oil prices reflect investors' preference for riskier assets, also sapping demand for haven bonds. The Dow Jones Industrial Average traded near 20,000, a level it has never crossed.

The Treasury is scheduled to see $34 billion of five-year notes Wednesday and $28 billion of seven-year notes Thursday. A $13 billion sale of two-year floating-rate notes is also scheduled for Wednesday.

The new two-year notes were sold at 1.28%, the highest yield for this maturity since 2008 as bond yields broadly have climbed over the past few months.

Indirect bidding for the auction was 32.7, the lowest since July. It is a measure of demand from foreign investors. Direct bidding, a gauge of demand that includes some large institutional investors and money managers, was 9.3%, the weakest since January 2015.

Government bond yields in the developed world have been rising after falling to their historic lows in the summer. The 10-year Treasury yield is up more than 1 percentage point from its record low set in early July. The yield was headed for a second consecutiveyear of gains, up from 2.273% at the end of 2015.

The shift toward higher yields over the past few months reflects rising expectations among investors toward a brighter growth outlook, higher inflation and potentially a faster pace of interest-rate increases by the Fed.

Selling in the bond market had intensified after the U.S. election in early November. The prospect of expansive fiscal policy from President-elect Donald Trump in the coming year has added to expectations of stronger economic growth and higher inflation.

These factors "are not going away and are likely to continue to pressure bond yields higher in 2017," said Praveen Korapaty, head of interest rate strategy at Credit Suisse.

Some investors and analysts say the bond market is on the process of normalizing from ultralow levels and that there is room for the yield to go higher if U.S. growth gains more traction. The 10-year yield was still less than half of where it traded in 2007.

Stocks and corporate bonds have outpaced Treasury debt this year. The Dow has handed investors a total return of 14% this year through Friday, according to FactSet. U.S. corporate bonds issued by lower-rated firms, or junk bonds, have logged a total return of 17% over the same period, beating 0.5% on Treasury debt, according to Bloomberg Barclays bond indexes data. Return includes price changes and interest or dividend payments.

The selling pressure eased last week, with the 10-year yield posting the first weekly decline in seven weeks. Some analysts say the selloff is overdone and that the 10-year yield around 2.6% attracts some buying interest.

Write to Min Zeng at min.zeng@wsj.com

(END) Dow Jones Newswires

December 27, 2016 13:58 ET (18:58 GMT)

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