TREASURIES-Yields rise on strong data; two-year auction slightly soft

(Adds data, auction results, updates prices) By Karen Brettell NEW YORK, Feb 21 (Reuters) - Treasury yields hit three-month highs on Tuesday as strong economic data led investors to price for higher interest rates, and after the Treasury Department saw slightly soft demand for a two-year note auction. Yields have jumped as bullish data and hawkish comments from Federal Reserve officials led investors to anticipate higher rates for longer as the U.S. central bank continues to battle stubbornly high inflation. The yields added to gains on Tuesday after data showed that U.S. business activity unexpectedly rebounded in February, reaching its highest level in eight months. The Fed is scheduled on Wednesday to release the minutes from its Jan. 31-Feb. 1 meeting, which will be evaluated for any new signs of how high the U.S. central bank is likely to ultimately raise rates. Fed Chair Jerome Powell's comments after that meeting had initially been interpreted as dovish, as he stressed the progress the central bank has made in bringing inflation off its peaks. But Fed officials since then have stressed that the battle is not over. "They are back to tough talk on inflation and with the additional economic news coming out that's been reasonably strong, the bond market's turned about-face and is pricing in a little bit more risk again," said Ellis Phifer, managing director of fixed income research at Raymond James in Memphis, Tennessee. Fed funds futures traders are now pricing for the Fed's benchmark overnight interest rate to reach 5.36% in July and end the year at 5.18%. Benchmark 10-year note yields reached 3.962%, the highest since Nov. 10. They are up from a four-month low of 3.321% on Jan. 19. Two-year yields rose as high as 4.738%, the highest since Nov. 8. The yield curve between two-year and 10-year notes remained deeply inverted at minus 78 basis points, indicating concerns over an impending recession. The Treasury market was closed on Monday for the Presidents' Day holiday. The Treasury sold $42 billion in two-year notes on Tuesday to slightly soft demand, the first sale of $140 billion in new coupon-bearing debt this week. The notes sold at a high yield of 4.673%, the highest two-year auction yield since July 2007 and slightly above where they had traded before the auction, according to analysts at Jefferies. Dealers took a lower share of the auction than their recent average, at 15%, indicating solid buyside demand. The bid-to-cover ratio was below average, however, at 2.61 times. The Treasury will also sell $43 billion in five-year notes on Wednesday and $35 billion in seven-year notes on Thursday. Other data on Tuesday showed that U.S. existing home sales dropped to the lowest level in more than 12 years in January, but the pace of decline slowed. The main U.S. economic focus this week will be the release on Friday of personal income and spending data for January. February 21 Tuesday 3:01PM New York / 2001 GMT Price Current Net Yield % Change (bps) Three-month bills 4.6975 4.8162 0.002 Six-month bills 4.84 5.0262 0.002 Two-year note 98-228/256 4.729 0.106 Three-year note 98-200/256 4.4407 0.120 Five-year note 97-8/256 4.1709 0.135 Seven-year note 96-120/256 4.0893 0.140 10-year note 96-76/256 3.9525 0.125 20-year bond 96-144/256 4.1294 0.105 30-year bond 93-232/256 3.9746 0.087 DOLLAR SWAP SPREADS Last (bps) Net Change (bps) U.S. 2-year dollar swap 30.50 -0.75 spread U.S. 3-year dollar swap 18.75 -0.50 spread U.S. 5-year dollar swap 5.75 -0.25 spread U.S. 10-year dollar swap -0.25 0.50 spread U.S. 30-year dollar swap -40.75 0.50 spread (Editing by Bernadette Baum and Paul Simao)