By Lukanyo Mnyanda and Wes Goodman Oct. 22 (Bloomberg) -- U.S. Treasuries rose, pushing the two-year yield to the lowest level in almost two weeks, as stocks fell and investors increased bets the Federal Reserve will cut interest rates to limit the severity of a recession. The odds on the Fed lowering its target rate for overnight loans between banks by a half-point next week rose to 78 percent, futures trading showed, as Minneapolis Fed President Gary Stern said policy makers' actions haven't calmed financial markets. Two-year Treasuries, more sensitive to monetary-policy changes, are headed for a fifth month of gains. ``The gains in Treasuries aren't surprising because the Fed's going to have to cut rates aggressively,'' said Stuart Thomson, a fund manager in Glasgow, Scotland at Resolution Investment Management Ltd., which oversees $46 billion in bonds. ``There's a chance we'll see a prolonged recession in the world economy.'' The yield on the two-year note fell 10 basis points to 1.52 percent, the lowest level since Oct. 10, as of 7:07 a.m. in New York, according to BG Cantor Market Data. The 2 percent security due September 2010 advanced 6/32, or $1.88 per $1,000 face amount, to 100 29/32. The 10-year note's yield slipped 8 basis points to 3.66 percent. Yields move inversely to bond prices. Investors should favor two-year notes and rate cuts by the Fed may help lower the yield to 0.75 percentage point by the end of January, Thomson said. That would be the lowest level since at least 1977 and compares with a median forecast of 1.66 percent by the end of March, according to analysts' and strategists' predictions compiled by Bloomberg. Wider Spread The difference between the two yields widened to 2.14 percentage points, from 1.38 percentage points three months ago as two-year yields fell faster than those on longer-dated debt. The spread ``should be twice what it is,'' Thomson said. The MSCI Asia Pacific Index of regional shares fell 5.4 percent, snapping a three-day rally, while Europe's Dow Jones Stoxx 600 Index declined 3.2 percent. ``Restoration of stability has not yet been achieved,'' Stern, the longest-serving Fed policy maker, said yesterday in the text of a speech in Escanaba, Michigan. The credit-market meltdown showed signs of affecting economies outside the U.S. Argentina's planned seizure of $29 billion of private pension funds stoked concern the nation is headed for its second default in a decade. South Korea South Korea is ready to take additional measures to restore confidence in its financial system if needed, the nation's top financial regulator said, after this week announcing it would guarantee $100 billion of banks' foreign-currency debt. ``The widening of stress beyond the developed markets' banking system and economies is not exactly what we need right now,'' Padhraic Garvey, head of investment-grade debt strategy at ING Bank NV in Amsterdam, wrote in a client note. ``There has generally been a move away from risky assets and back into core safety, a theme that we expect to remain with us through to year-end at the very least.'' The U.S. economy is getting worse, said Mickey Levy, chief economist at Bank of America Corp. in New York. ``We are already in recession'' in the U.S., he said in an interview yesterday. ``It's deepening. We're in the middle of a crisis in confidence.'' The U.S. central bank invoked emergency authority yesterday to provide up to $540 billion in loans to help relieve pressure on money-market mutual funds beset by redemptions. The program ``should improve the liquidity position of money-market investors,'' the central bank said. Credit Squeeze Credit markets are starting to improve as the Fed adds dollars to the banking system, which will curtail demand for Treasuries, said Peter Jolly, head of markets research in Sydney at NabCapital, the investment-banking unit of National Australia Bank Ltd., the nation's largest lender. ``It'll be hard for them to rally,'' Jolly said. ``The fix is in the financial markets. Risk aversion should recede.'' Ten-year yields will rise to 4 percent by June, while two- year yields already reflect forecasts for lower borrowing costs, he said. Two-year notes yield about 6 basis points more than the central bank's key rate. The spread has averaged about 24 basis points over the past decade. Banks' borrowing costs fell after the Fed agreed to provide loans to money-market funds and the Bank of Japan refrained from injecting additional liquidity due to improved funding conditions. The London interbank offered rate, or Libor, for overnight loans slid 16 basis points to 1.12 percent, the lowest level since June 2004, according to data from the British Bankers' Association. TED Spread The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, narrowed for an eight day to 2.48 percentage points. A measure of the scarcity of cash also eased. The difference between the rate banks charge each other for three-month dollar loans relative to the overnight indexed swap rate, the so-called Libor-OIS spread, narrowed 28 basis points to 2.5 percentage points. It was 3.66 percentage points on Oct. 10. Treasuries returned 0.8 percent this month, according to Merrill Lynch & Co.'s U.S. Treasury Master Index. The Standard & Poor's 500 Index fell 35 percent this year and credit market losses since the start of 2007 climbed to $659 billion, spurring demand for the safest assets. ``The market is running on fear,'' Arthur Bass, a managing director of derivatives in New York at the brokerage Newedge USA LLC, said yesterday. ``It is fear and expectations of rate cuts and more federal interventions -- whatever they can do to help the markets.'' To contact the reporters on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net; Wes Goodman in Singapore at wgoodman@bloomberg.net

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