Sept. 26 (Bloomberg) -- U.S. Treasuries fell as two Federal Reserve officials said the economy remains strong after two hurricanes struck the Gulf Coast, bolstering views the central bank will keep raising interest rates.

Government debt fell for a third day as Chicago Fed President Michael Moskow said ``the fundamentals of the economy are strong,'' and Fed Governor Susan Bies said there is ``underlying core resilience.'' A drop in crude oil to a two-week low after Hurricane Rita caused only minor disruptions at Houston-area refineries kicked off the declines in Treasuries in overnight trading.

``The market expectation for the Fed to continue on that measured course is firmly in pace,'' said David Glocke, a principal at Vanguard Group Inc. in Valley Forge, Pennsylvania, who manages about $10 billion in Treasury bond funds. He said his short- and intermediate-term funds are in the ``bearish band.'' Rita ``did not turn out to be as bad as expected.''

The yield on the benchmark 10-year note rose 5 basis points, or 0.05 percentage point, to 4.30 percent, the highest in six weeks, at 4 p.m. in New York, according to bond broker Cantor Fitzgerald LP. The yield, which moves inversely to the bond's price, is used to help set corporate and consumer borrowing rates.

The price of the 4 1/4 percent security due in August 2015 fell almost 7/16, or $4.38 per $1,000 face amount, to 99 19/32.

The two-year note's yield, more closely linked to the Fed's benchmark rate, increased 3 basis points to 4.06 percent, and is up from 3.86 percent on Sept. 22.

Fed policy makers lifted their target for the overnight lending rate between banks for the 11th straight time last week, to 3.75 percent from 3.50 percent. Hurricane Katrina, which hit the Gulf Coast less than a month before Rita, would be a ``near- term'' setback for the economy, they said in a statement announcing the Sept. 20 decision.

Fundamentals `Are Strong'

``It's early to see the results of Rita, but I think the fundamentals of the economy are strong,'' Moskow said in comments to reporters after a speech to the National Association for Business Economics in Chicago.

``All of the rebuilding that's going to be required is also going to show up in the economic numbers once we get through the initial impact,'' Bies said to reporters after a presentation to the Institute of International Bankers in Washington.

Fed governors always vote when the central bank decides on interest rates, while branch presidents rotate. Moskow votes this year.

Greenspan Speech

Fed Chairman Alan Greenspan tomorrow is slated to discuss economic flexibility in a speech to the NABE via satellite at 2:45 New York time. He said today in a speech that declines in mortgage rates even as the federal funds target rose have encouraged speculation in the housing market.

Yields on interest-rate futures rose as traders priced in higher odds of increases in the central bank's target for the overnight lending rate between banks. December federal funds futures yield 4.07 percent, the highest since Aug. 29, the day Katrina made landfall.

``Last week the market was clearly betting that the Fed would not be raising rates for much longer, despite what they said in the post-meeting statement,'' said William Prophet, an interest-rate strategist at UBS Securities LLC in Stamford, Connecticut. ``The market is having a change of heart.''

UBS, one of the 22 primary U.S. government securities dealers that trade with the Fed's New York branch, expects the 10-year yield to rise to 5 percent by year-end as the Fed raises the fed funds target at both of its remaining meetings, to 4.25 percent.

Yield Curve

The gap between two- and 10-year yields was little changed at 24 basis points, within a basis point of the narrowest since Aug. 31, and down from 33 basis points on Sept. 19. The gap, known as the yield curve, widened from a four-year low of 12 basis points after Katrina struck, on the view damage to the economy might cause the Fed to slow the pace of rate increases.

Declines in fuel prices over the past week tempered concern consumers will pare spending, which accounts for two-thirds of the economy.

Crude oil futures on the New York Mercantile Exchange, which rose to a record $70.85 a barrel Aug. 30, rose 2.5 percent but remain below the two-week high of $68.27 they touched on Sept. 21 as Rita approached Texas.

Gasoline futures, which rose to a record $2.92 a gallon on Aug. 31, gained 2 percent to $2.13 a gallon, below their peak last week of $2.20 on Sept. 22.

No `Potential Damper'

``The potential damper on economic activity is less than expected, hence higher rates,'' said Scott Peng, head of U.S. interest-rate strategy at New York-based Citigroup Global Markets Inc., a unit of the world's largest bank. Peng recommends investors bet on a narrowing in the yields between one- and three-year Treasuries.

Sales of previously owned homes surged to the second-highest level on record in August, increasing 2 percent to a 7.29 million annual rate, National Association of Realtors said today.

Declines in European government bonds after European Central Bank policy makers said interest rates may need to rise also triggered selling of Treasuries to keep the difference in yields stable, said Michael Franzese, head of U.S. Treasury trading at Zions First National Bank in Jersey City, New Jersey.

``The European market looked weak, and that forced spread selling in U.S. Treasury market against it,'' Franzese said. The U.S. 10-year note's yield exceeds that of the German bund by 117 basis points, little changed from 119 basis points on Sept. 23. The bund's yield rose 5 basis points to 3.11 percent.

Bond Slump

Treasuries are down 0.68 percent, including reinvested interest, this quarter through Sept. 23, according to Merrill Lynch & Co. index data. The performance is the worst since a 3.08 percent drop in the period ended June 2004 and follows a 3.59 percent rally last quarter.

Large speculators for the first time since July 1 are expecting a drop in 10-year notes through futures contracts. Speculative short positions, or bets prices will fall, outnumbered long positions by 19,654 contracts on the Chicago Board of Trade for the week ended Sept. 20.

Declines in Treasuries may be limited on speculation a report tomorrow will show consumer confidence was the weakest since November. The Conference Board's consumer confidence index probably fell to 95 in September from 105.6 in August, according to the median estimate of 51 economists surveyed by Bloomberg.

`A Good Buy'

``Treasuries are a good buy,'' said Kazuaki Oh'e, a bond salesman in Tokyo at CIBC World Markets Corp. ``The confidence report may signal consumers worried about the economy.''

Ten-year yields may decline to 4.15 percent, Oh'e said.

Two-year notes fell before a government auction of the securities on Sept. 28. The U.S. today said it will sell $20 billion of two-year notes.

Two-year note yields may rise to 4.5 percent within three months, the highest since April 2001, said Guy Williams, head of global fixed-income in London for Fortis Investments, which oversees $112 billion.

``I cannot understand two-year securities in the U.S.,'' said Williams. ``The Fed has gone out of its way in saying there's confirmation of underlying growth and we're going to look past any problems from the hurricanes.'' He doesn't plan to buy at this week's auction.

The volume of Treasuries traded today through ICAP Plc., the world's largest inter-bank broker, was about $172.7 billion, compared with the three-month daily average of $208.7 billion.

To contact the reporter on this story: Elizabeth Stanton in New York at estanton@bloomberg.net

Last Updated: September 26, 2005 16:08 EDT