By Sandra Hernandez Oct. 17 (Bloomberg) -- Treasury 10-year notes fell for a second straight week as the haven appeal of government debt waned in the wake of Treasury Secretary Henry Paulson's plan for the government to invest in banks. Traders pushed 10-year yields above 4 percent this week for the first time since August. The notes also slumped on speculation the U.S. would hold impromptu auctions to relieve shortages in the market for borrowing and lending Treasuries, and to increase overall debt supply to pay for actions to rescue the financial system. ``Some of the negativity we were seeing a week ago has been alleviated,'' said Kevin Flanagan, a fixed-income strategist at Morgan Stanley Global Wealth Management Group in Purchase, New York. Ten-year notes are ``going to have to deal with the ramifications of the huge amounts of Treasury supply that have to come to market to fund the programs being put in place.'' The yield on the 10-year note fell 4 basis points, or 0.04 percentage point, to 3.92 percent at 4:04 p.m. in New York, according to BGCantor Market Data. It increased 5 basis points this week, touching a 2 1/2-month high of 4.10 percent on Oct. 15. The 4 percent security maturing in August 2018 gained 10/32, or $3.13 per $1,000 face amount, to 100 20/32. Yields on two-year notes fell 2 basis points to 1.61 percent. They were down 4 basis points for the week. Gross on Treasuries The difference between two- and 10-year note yields could widen to 2.75 percentage points in 2009, with 10-year yields possibly rising to 4.75 percent, Flanagan said. The gap, known as the yield curve, was 2.32 percentage points today. ``I don't think you buy Treasuries,'' said Bill Gross, who is co-chief investment officer of Newport Beach, California- based Pacific Investment Management Co. and runs the firm's $129.6 billion Total Return Fund. ``They're obvious flight-to- quality vehicles.'' He spoke in a Bloomberg Radio interview. The U.S. and other nations have agreed to spend $3 trillion to rescue banks imperiled by the credit crisis. The U.S. on Oct. 14 said it plans to buy $250 billion of shares in banks and will fully guarantee newly issued, senior unsecured bank debt. The government guarantee has raised the appeal of bank debt relative to the so-called agency securities of Fannie Mae and Freddie Mac, Gross said. That has led to a widening of the yield gap between Treasuries and agencies, he said. `Hit Really Hard' The difference between yields on Washington-based Fannie's five-year debt and similar-maturity Treasuries was 124 basis points today, compared with 102.4 basis points a week ago, according to data compiled by Bloomberg. Treasuries lost 0.02 percent so far this month, while agency benchmark notes slumped 0.38 percent, according to bond indexes compiled by Merrill Lynch & Co. The Standard & Poor's 500 Index has shed 19 percent in the same period. It fell 0.2 percent today while gaining 4.6 percent on the week. Ten-year notes underperformed two-year notes this week amid speculation the government would hold a second set of special auctions of longer-term Treasuries to relieve shortages in the market for borrowing and lending government debt. The U.S. on Oct. 8 and 9 sold $40 billion in debt over two days in special sales it announced on Oct. 8. ``On a daily basis, people have been looking for the Treasury to come in and make another announcement,'' said Tom Tucci, head of U.S. government bond trading in New York at RBC Capital Markets, the investment-banking arm of Canada's biggest lender. Treasuries with five-, seven- and 10-year maturities ``had been hit really hard'' as traders anticipated new auctions. Treasury Bills The government last week also said it would continue increasing sizes of regular debt sales and consider selling new maturities, making any changes to its auction calendar at its Nov. 5 refunding announcement. Yields on three-month Treasury bills, viewed as a haven because of their short maturities, rose 37 basis points today to 0.79 percent, the highest level since Oct. 7. The Treasury today auctioned a combined $60 billion in 74-day and 94-day securities. While economic reports this week showed slowing in housing starts, industrial production and retail sales, money markets exhibited signs of thawing. The London interbank offered rate, or Libor, for borrowing in dollars overnight fell for a sixth day, slipping 27 basis points to 1.67 percent. That's the lowest level since September 2004. TED Spread Narrows The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, was 3.63 percentage points, down from 4.64 percentage points at the end of last week. Traders added to bets the Federal Reserve will cut borrowing costs for a second time this month at its Oct. 29 meeting to bolster the economy. Futures on the Chicago Board of Trade show traders see a 44 percent chance the Fed will cut its target rate for overnight bank loans by a half-percentage point to 1 percent at the end of the month. The likelihood was 28 percent a week ago. The rest of the bets are for a quarter-point reduction. Housing starts in the U.S. fell more than forecast in September as construction of single-family homes plunged to the lowest level in 26 years, dropping 12 percent to a 544,000 annual rate, according to the Commerce Department. To contact the reporter on this story: Sandra Hernandez in New York at shernandez4@bloomberg.net

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