By Deborah Levine

Treasury prices declined Tuesday as yields moved higher, after Federal Reserve Chairman Ben Bernanke said more government action would be needed to strengthen the financial system.

Two-year note yields (UST2YR) rose 2 basis points to 0.76%. A basis point is one one-hundredth of a percent.

Ten-year note yields (UST10Y) rose 3 basis points to 2.33%.

The timing and strength of any global recovery remain "highly uncertain," Bernanke said in a speech in London.

Bernanke said the next step should be getting toxic assets, like those tied to subprime mortgages, off bank balance sheets -- the original intent of the Troubled Asset Relief Program funding.

He also said the Fed may expand its program to buy asset-backed securities, which pool borrowings such as car and student loans and credit-card debt.

"We'll see a continuing shift of risky assets from the private sector to the public sector," said Mustafa Chowdhury, head of U.S. interest rate research at Deutsche Bank. "The challenge is that the government will need to borrow a lot."

Treasury issuance could exceed $2 trillion in the remaining three quarters of 2009, much more than the government's official estimates, according to Chowdhury.

"They need bigger guns to handle consumer credit," which includes mortgages and car loans, than the amount spent for far shoring up banks, he said.

Bernanke also restated that the U.S. central bank could buy longer-term Treasurys to keep loan rates low.

The Fed has begun buying billions of dollars in mortgage-backed securities and debt sold by housing agencies including Fannie Mae (FNM) and Freddie Mac (FRE) to lower mortgage rates and spur growth in the housing market.

So far, the program has been successful in bringing down mortgage rates by reducing the gap between Treasurys, a benchmark for many types of loans, and yields on mortgage or agencies bonds.

Demand for Treasurys also waned as other sectors showed signs of improvement.

Short-term interbank lending markets seem to be improving. The Fed again didn't even receive enough bids to loan the amount available at Monday's Term Auction Facility offering, indicating banks have sufficient liquidity. The Fed loaned $107.7 billion in 28-day loans, after offering $150 billion.

Traders also noted more corporate bond sales, including possibly from McDonald's (MCD) and FedEx (FDX), which could trigger some selling of Treasurys used as hedges.

Also Tuesday, a government report showed the U.S. trade deficit in November plunged to $40.4 billion, reflecting lower oil prices and weakening demand for imports as the nation's economic woes deepened.

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