By Bo Nielsen and Wes Goodman Oct. 9 (Bloomberg) -- Treasuries dropped for a third day as stocks rose after central banks from the U.S. to China cut interest rates yesterday in an attempt to restart the flow of credit and prevent a global recession. U.S. debt declined after the Federal Reserve, European Central Bank, Bank of England, Bank of Canada and Sweden's Riksbank yesterday lowered their benchmark rates by a half point. The Treasury plans to issue $20 billion of notes due February 2015 and February 2018 plus $30 billion of short-term bills today as it tries to relieve shortages caused by people hoarding U.S. securities. ``We're looking at an unwind of some of the excesses of the flight to safety in the last couple of weeks,'' said Padhraic Garvey, an Amsterdam-based debt strategist with ING Bank NV. ``But it's not aggressive enough to suggest the flight to safety is over. It all boils down to whether money-market rates fall.'' Yields on two-year notes increased 7 basis points to 1.62 percent as of 7:18 a.m. in New York, according to BGCantor Market Data. The 2 percent security due September 2010 fell 4/32, or $1.25 per $1,000 face amount, to 100 23/32. The yield on the 10-year note rose 7 basis points to 3.72 percent. A basis point is 0.01 percentage point. Two-year yields have fallen 55 basis points in two weeks as investors sought refuge in Treasuries amid the deepening credit crunch. The spread between two- and 10-year yields widened to 2.11 percentage points, the most since June 2004, from 2.10 percentage points yesterday. U.S. Banks U.S. Treasury Secretary Henry Paulson yesterday indicated the government may invest in banks as the next step in trying to resolve the seizure in credit markets. Legislation passed last week may be used beyond just buying mortgage-related assets on banks' balance sheets, he told reporters in Washington. ``There's no liquidity in the market,'' said Kei Katayama, who oversees $1.6 billion of non-yen debt as leader of the foreign fixed-income group in Tokyo at Daiwa SB Investments Ltd., part of Japan's second-biggest investment bank. ``No one wants to increase risk.'' The MSCI World Index added 0.5 percent today after slumping 15 percent in the past five days, the biggest drop since October 1987. Standard & Poor's 500 Index futures rose 1.4 percent. Central banks in South Korea, Taiwan and Hong Kong cut interest rates today, a day after their counterparts in the U.S., Europe and China coordinated monetary easing to stem the damage of the global financial crisis. More Cuts Likely ``While the shifts may begin to turn around the acceleration in negative sentiment that has gripped financial markets, there is likely to be significant further easing around the world before we are done,'' Dominic Wilson, a London-based Goldman Sachs Group Inc. economist, wrote to clients today. The London interbank offered rate, or Libor, that banks charge each other for three-month loans jumped to the highest level since December, the British Bankers' Association said today. It rose 23 basis points to 4.75 percent, the BBA said. It was at 2.82 percent a month ago. Two-year notes, among the most sensitive to changes in interest rates, are the best bet in the Treasury market now, said Hideo Shimomura, chief fund manager at Mitsubishi UFJ Asset Management Co. in Tokyo. ``We favor short-term Treasuries,'' said Shimomura, who oversees $4 billion in non-yen bonds at the unit of Japan's largest bank. ``You can expect further cuts.'' Two-year yields will fall to 1.2 percent by the end of the year, he said. Futures contracts on the Chicago Board of Trade show an 82 percent chance the Fed will reduce its target rate for overnight bank loans, now 1.5 percent, by a quarter point at its meeting on Oct. 29. Shunning Treasuries At Toyota Asset Management Co. in Tokyo, chief portfolio manager Satoshi Arai said he is avoiding U.S. 10-year notes because supply is increasing. Ten-year yields may rise to 4 percent over the next six months, and two-year rates will be little changed, said Arai, who oversees $12 billion at the firm. The U.S. Treasury sold $20 billion of notes and $40 billion of bills yesterday to alleviate ``protracted shortages.'' Treasury markets have been struggling with elevated numbers of transactions that don't settle properly, called failed trades or fails, in part because U.S. government securities have been in such high demand. The difference between what banks and the Treasury pay to borrow three-month money, the so-called TED spread, widened to 4.11 percentage points today, the most since Bloomberg began compiling the data in 1984, from 3.91 percentage points yesterday. That compares with 1.16 percentage points a month ago. British Bailout Britain became the latest government to bail out its banking system, announcing an unprecedented 50 billion-pound ($86.2 billion) government lifeline and emergency loans from the Bank of England. The International Monetary Fund said the world's advanced economies will grow next year at the slowest pace since 1982, easing inflation pressures and boosting unemployment. The median estimate of economists surveyed by Bloomberg News is for the U.S. economy to expand 1.5 percent in 2009. The deepening economic slowdown is prompting traders to reduce their expectations for inflation. U.S. yields indicate they fell to the lowest in almost a decade yesterday. The difference between yields on 10-year Treasury Inflation Protected Securities, or TIPS, and regular notes narrowed to 1 percentage point, the least since February 1999. The so-called breakeven rate reflects the outlook among traders for consumer prices over the next 10 years. To contact the reporters on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net; Wes Goodman in Singapore at wgoodman@bloomberg.net

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