By Dakin Campbell and Bo Nielsen Oct. 29 (Bloomberg) -- Treasuries rose for the first time in three days, led by two-year notes, on speculation the Federal Reserve will cut its key interest rate by a half-percentage point today to 1 percent. U.S. government securities headed for a fifth monthly gain after former Fed Governor Frederic Mishkin said the market shock is ``more pervasive'' than during the Great Depression. Two-year note yields were 10 basis points above the Fed's target rate for overnight loans, compared with the 17-point average in the last three months, after the U.S. sold $34 billion of the notes yesterday at better-than-average demand. ``The two-year has been a reflection of the Fed easing,'' said Lawrence Dyer, an interest-rate strategist in New York at HSBC Securities USA Inc., one of the 17 primary dealers that trade with the U.S. central bank. ``Unless there is some additional dramatic action, I'd look at two-years as staying in a volatile trading range reflecting illiquidity and the potential the Fed would ease lower.'' Two-year yields fell 6 basis points to 1.60 percent at 8:51 a.m. in New York, according to BGCantor Market Data. The 1.5 percent security maturing in October 2010 increased 3/32, or 94 cents per $1,000 face amount, to 99 26/32. Ten-year yields decreased 1 basis point to 3.84 percent. A basis point is 0.01 percentage point. `Looking for a Rate Cut' ``People are looking for a rate cut by the Fed, and that's fueling Treasury buying,'' said David Keeble, head of fixed- income strategy in London at Calyon, the investment-banking arm of Credit Agricole SA. ``With a lot of the supply out of the way, it enabled us to start buying again.'' Futures on the Chicago Board of Trade show a 100 percent probability the central bank will trim its target rate for overnight bank loans to by at least a half-percentage point from 1.5 percent. The odds increased from no chance a month ago. U.S. stock futures were little changed. The Standard & Poor's 500 Index soared 11 percent yesterday, paring this year's decline to 36 percent, its steepest annual drop since 1937. The index and two-year Treasuries moved in opposite directions 88 percent of the time in the past three months, Bloomberg data show. The Fed will lower its benchmark rate by half a percentage point today and by the same amount at its Dec. 16 meeting, Standard Chartered predicted yesterday. ``We continue to look for the U.S. two-year to head for the sub-1 percent area,'' Padhraic Garvey, the Amsterdam-based head of interest-rate strategy for ING Bank NV, wrote in a note today. `No Hurry' The Fed cut its key interest rate by half a percentage point on Oct. 8 in a coordinated effort with other major central banks to quell financial turmoil and avert a recession. It has slashed the rate from 5.25 percent since September 2007 as the crisis in credit markets intensified. ``In its statement the Fed will probably try to create the impression that it is in no hurry at all to take action in order to tighten the currently very accommodative monetary policy,'' Peter Mueller, a fixed-income strategist in Frankfurt at Commerzbank AG, Germany's second-largest bank by assets, wrote in a note today. ``The short ends of the curve should remain very well supported.'' Inflation Expectations Orders for U.S. durable goods excluding transportation equipment fell in September for a second month, by 1.1 percent, the Commerce Department said in Washington. A rebound in aircraft orders, a volatile category, and an increase in defense bookings unexpectedly pushed total orders up 0.8 percent. The U.S. economy probably shrank in the third quarter for the second time in a year, contracting at a 0.5 percent annual rate, the most since the 2001 recession, according to economists surveyed by Bloomberg. Commerce Department figures on gross domestic product are due Oct. 30. Traders have scaled back their estimates for inflation over the next decade as the economy stalled and oil prices fell 55 percent from a record in July. The difference between yields on 10-year Treasury Inflation Protected Securities, or TIPS, and conventional notes, narrowed to 0.82 percentage point, from 1.62 percentage points a month ago. ``We have had a major deflationary shock,'' Mishkin said yesterday on Bloomberg Television. Yields indicate banks are less willing to lend than earlier in 2008. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, widened to 2.75 percentage points, from this year's low of 0.76 percentage point in May. The figure was 4.64 percentage points on Oct. 10, the most since Bloomberg data began in 1984. Treasury Supply The U.S. sold $34 billion of two-year notes yesterday, matching a record, drawing yields of 1.60 percent, the lowest since March 2004. It plans to sell $24 billion five-year securities tomorrow. It will announce on Nov. 5 how it plans to boost its debt sales later in the month. Ten-year securities fell the most in two weeks yesterday after Anthony Ryan, acting Treasury undersecretary for domestic finance, said the U.S. may sell more long-term debt to address ``unprecedented'' needs to finance a growing budget deficit. Treasuries returned 0.5 percent in October, according to Merrill Lynch & Co.'s U.S. Treasury Master index. To contact the reporters on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net; Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net

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