By Dakin Campbell and Bo Nielsen Oct. 31 (Bloomberg) -- Treasuries rose, with two-year notes headed for the best month since February, on speculation the U.S. economy will continue to deteriorate, boosting demand for the safest assets. Treasuries gained before a U.S. government report that is forecast to show consumer spending fell in September for the first time in two years. Federal Reserve Bank of San Francisco President Janet Yellen said last night the central bank would lower benchmark interest rates close to zero percent if the economy stayed weak. The Bank of Japan became the latest central bank to slash rates to help stave off recession. ``There is concern about weak economies around the world getting worse,'' said Theodore Ake, the head of Treasury trading in New York at Mizuho Securities USA Inc., one of the 17 primary dealers that trade with the Fed. ``We saw Japan chop rates last night by 20 basis points, Yellen's statement overnight about possibly going to zero percent interest rates in the U.S., and when you put it all together you end up with a steeper curve.'' The yield on the 10-year note fell 9 basis points, or 0.09 percentage point, to 3.88 percent at 8:14 a.m. in New York, according to BGCantor Market Data. The 4 percent security maturing August 2018 rose 22/32, or $6.88 per $1,000 face amount, to 101. Two-year yields declined 4 basis points to 1.52 percent. U.S. debt returned 4.6 percent so far in 2008, on top of a 9 percent return last year, according to Merrill Lynch & Co.'s Treasury Master index. Mizuho Forecast Ten-year yields will drop to 3.4 percent by year-end, according to Mizuho Asset Management, which oversees the equivalent of $40.7 billion as part of Japan's second-largest bank. Futures on the Chicago Board of Trade show a 75 percent chance the Fed will reduce its target rate to 0.5 percent at its Dec. 16 meeting. The odds a week ago were zero. The rest of the bets are for a quarter-percentage point reduction. The Fed cut its target rate for overnight bank lending by half a percentage point Oct. 29 to 1 percent, the lowest level since June 2004, saying ``downside'' risks to growth remain. The economy declined in the third quarter the most since 2001, a Commerce Department report showed yesterday. Treasuries may gain after a report likely shows consumer spending slipped 0.2 percent in September, according to the median estimate in a Bloomberg News survey of economists before the Commerce Department issues the figure at 8:30 a.m. in Washington. Consumer Confidence A Reuters/University of Michigan index due at 10 a.m. will likely say consumer sentiment this month fell to 57.5 from 70.3 in September, another survey showed. ``Well, let's face it, things are bad and rate cuts for core markets are the way to go in the coming months,'' Padhraic Garvey, head of investment-grade debt strategy at ING Bank NV, wrote in a note today. ``There's still a steepening theme with extra supply next year also likely to hurt the 10-year area more than other maturities.'' The difference in yield, or spread, between two- and 10- year securities widened to 2.37 percentage points, near the most since 2004, from 2.17 points a week ago. The so-called yield curve has steepened as longer-term securities lagged behind in anticipation of increased government debt auctions. Debt Sales Treasuries trimmed gains from earlier in the month because of concern U.S. efforts to thaw credit markets and prop up the financial system will swell sales of long-term government debt. U.S. borrowing needs will almost double this fiscal year to $2 trillion, Goldman Sachs Group Inc. forecast. The government auctioned off $64 billion in 2- and 5-year notes and five-year Treasury Inflation Protected Securities this week. The Treasury is scheduled to announce Nov. 5 how it will boost debt sales. It has said it will have a decision at that time on reviving the three-year note and holding more frequent 10- and 30-year securities sales. ``A huge amount of supply is coming,'' 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 go to the longer end of the market.'' U.S. government securities returned 0.04 percent this month as of yesterday, according to Merrill Lynch's U.S. Treasury Master index. German government bonds handed investors 2.7 percent in October, and Japanese debt earned 0.4 percent. Bank Lending Yields indicate banks are more willing to lend than they were three weeks ago after governments bailed out lenders and policy makers slashed interest rates and pumped trillions of dollars into money markets to restore confidence. The difference between banks and the Treasury pay to borrow money for three months, the so-called TED spread, narrowed to 2.64 percentage points from a high of 4.64 percent Oct. 10. To contact the reporter on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net; Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net.

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