By Sandra Hernandez and Cordell Eddings Nov. 12 (Bloomberg) -- Treasuries rose, sending two-year note yields to a five-year low, as a drop in stocks boosted demand for government debt and traders added to bets policy makers will cut interest rates to spur a weakening economy. U.S. government bonds climbed for a second day as the economic crisis threatened to topple automaker General Motors Corp. and the Federal Reserve urged banks to keep up lending. The Treasury Department plans to sell a record $20 billion of 10-year notes today to finance economic-assistance programs, including a $700 billion bank-rescue plan, and make up for falling tax income. ``To the extent you're seeing more and more signs of the financial market turmoil going into the real economy, you end up viewing it as the fed funds rate could fall further and stay low longer,'' said Lawrence Dyer, an interest-rate strategist in New York at HSBC Securities USA Inc., one of the 17 primary dealers that trade bonds with the Federal Reserve. ``It's good for Treasuries; it ought to be bad for everything else.'' The two-year note yield fell 5 basis points, or 0.05 percentage point, to 1.20 percent at 11:28 a.m. in New York, according to BGCantor Market Data. It touched 1.18 percent, the lowest since June 2003. The 1.5 percent security due in October 2010 rose 3/32, or 94 cents per $1,000 face amount, to 100 18/32. The 10-year note's yield dropped 6 basis points to 3.69 percent. The 10-year security to be sold at 1 p.m. New York time yielded 3.77 percent in pre-auction trading. The Standard & Poor's 500 Index retreated for a third day, falling 2.9 percent, and the MSCI World Index lost 2.7 percent. Bank Lending The last time two-year note yields dropped beneath today's low was June 25, 2003, the day Fed policy makers under Chairman Alan Greenspan cut the benchmark lending rate to 1 percent, a half-century low, citing the risk of a ``substantial fall in inflation.'' ``Yesterday's dip in the equity market and then today's continued softening is the biggest driver in the Treasury market right now,'' said Michael Cloherty, head of Treasury and agency strategy at the primary dealer Banc of America Securities LLC. ``Now expectations are that the fed funds rate is going to stay low for longer, and some of these supply fears have dissipated,'' he said, referring to this week's $55 billion in note and bond auctions. Futures on the Chicago Board of Trade show traders see a 90 percent chance the Fed will lower its 1 percent target rate for overnight bank lending by a half-percentage point at its Dec. 16 meeting. The odds a week ago were 50 percent. 3 Percentage Points ``We're all looking for negative growth; the market expects inflation to abate,'' said John Spinello, chief technical strategist in New York at Jefferies Group Inc. Because their fixed returns are eroded by rising consumer prices, bonds benefit from falling inflation. The difference between two- and 10-year note yields could widen to 3 percentage points ``over the long term,'' Spinello said. It touched a five-year high of 2.50 percentage points on Nov. 10 as two-year notes, the most sensitive to expectations about monetary policy, led gains. The yield gap narrowed to 2.48 percentage points today. Traders can bet on a widening yield gap by buying two-year notes and selling 10-year notes. Treasury investors were more bullish this week, a weekly survey of clients by JP Morgan Securities showed. The net percentage of investors betting on rising prices climbed to 27 percent, from 23 percent last week. The figure is the difference between the percentage of investors holding long positions, or bets on higher prices, and those taking short positions, bets on falling prices. The majority of respondents expected no change. TED Spread Yields indicate banks are less willing to lend to each other. The difference between what they and the Treasury pay to borrow money for three months, the so-called TED spread, widened to 1.98 percentage points, from 1.75 percentage points yesterday. The spread expanded to 4.64 percent on Oct. 10, the most since Bloomberg began compiling the data in 1984. Yields on three-month Treasury bills, viewed as a haven in times of turmoil, fell 27 basis points to 0.15 percent, the lowest in almost a month. GM climbed from the lowest level since 1943 today as U.S. House Speaker Nancy Pelosi urged Congress to pass an auto- industry bailout. Shrinking Economy Analysts surveyed by Bloomberg News forecast U.S. gross domestic product will shrink 0.4 percent this quarter after an annualized 0.30 percent contraction in the three months ended September. Treasury Secretary Henry Paulson scrapped an effort to buy devalued mortgage assets from banks through a $700 billion rescue program, saying he will focus on relieving pressures on consumer credit. ``Illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards,'' Paulson said in the text of a speech today in Washington. ``This is creating a heavy burden on the American people and reducing the number of jobs in our economy.'' At the last sale of 10-year notes last month, investors bid for 2.31 times the amount of debt available. The auction was one of four $10 billion offerings held over two days to alleviate shortages of the securities. The average for the previous 10 sales is 2.18. The U.S. auctioned $25 billion of three-year debt on Nov. 10 and plans to sell $10 billion of 30-year bonds tomorrow in its biggest quarterly refunding since 2004. Investors bid for 3.07 times the amount of three-year debt offered yesterday, the most since 1998. To contact the reporters on this story: Sandra Hernandez in New York at shernandez4@bloomberg.net; Cordell Eddings in New York at ceddings@bloomberg.net;

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