By Wes Goodman and Gavin Finch Nov. 24 (Bloomberg) -- Treasuries fell as traders prepared for a $36 billion auction of two-year notes amid speculation a bailout of U.S. banks will force President-elect Barack Obama to spend more than previously estimated to boost the economy. The drop pushed the two-year yield to the highest level in three days as Citigroup Inc. received government guarantees for tainted assets and a injection to stabilize the bank after its stock fell 60 percent last week. Treasuries also slipped on expectations the government’s economic stimulus plan will run to $700 billion or more, exceeding the $175 billion package Obama proposed a month ago. “We’ve got some very expensive yield levels now,” said David Keeble, the London-based head of fixed-income strategy at Calyon, the investment-banking unit of France’s Credit Agricole SA. “I don’t see this rally continuing as I’m not convinced the U.S. economy is going to sink into a black hole.” The yield on the two-year note rose seven basis points, or 0.07 percentage point, to 1.18 percent by 6:55 a.m. in New York, according to BGCantor Market data. The 1.5 percent security due October 2010 fell 4/32, or $1.25 per $1,000 face amount, to 100 20/32. The 10-year note yield increased one basis point to 3.24 percent. The Treasury Department is also scheduled to sell $26 billion of five-year notes this week to pay for the bank rescue plan implemented by George W. Bush’s administration. Demand at the last sale of two-year notes on Oct. 28 was stronger than the average at the last 10 auctions, judging by the bid-to-cover ratio, which compares the number of bids with the amount of securities offered. The ratio was 2.49 at the last sale, compared with an average of 2.31. Citigroup Support Citigroup, whose stock fell 60 percent last week, will receive protection against “unusually large losses” on $306 billion of assets and get an investment of $20 billion from the U.S. Treasury, according to a government statement. General Motors Corp., in danger of running out of cash, will seek to cut its debt and to negotiate new union rules to help it win federal loans, people familiar with the plan said. Ten-year yields will rise to 4 percent by Dec. 31, from 3.23 percent at the end of last week, Deutsche Bank economists Joe LaVorgna and Carl Riccadonna in New York wrote to clients on Nov. 21. A Bloomberg survey of banks and economists shows the figure will increase to 3.69 percent, with the most recent forecasts given the heaviest weightings. Congress will send President-elect Barack Obama an economic stimulus package the day he takes office on Jan. 20, two Democratic lawmakers said yesterday. Timothy Geithner, head of the Federal Reserve Bank of New York, will be nominated as Treasury secretary, and Lawrence Summers will head the National Economic Council, Democratic aides said. Obama Appointments Obama’s incoming administration may also enlarge the $700 billion financial-rescue fund enacted last month. It may surge to perhaps $1.2 trillion, said Martin Baily, who served as White House chief economist under Clinton and is now at the Brookings Institution in Washington. U.S. yields tumbled to record lows last week, with the three-month bill at 0.01 percent, as the U.S. recession fueled demand for sovereign debt. Treasuries are in such demand that investors are lending money for almost nothing to obtain the securities through so- called repos, which dealers use to finance their holdings. In the $7 trillion-a-day repurchase market, one party provides cash to another in exchange for a security, and vice versa. Failed Trades One problem is that many parties aren’t delivering the bonds because there is no penalty for not doing so, causing “fails” to exceed $5 trillion a week, according to the Federal Reserve Bank of New York. The Treasury Market Practices Group wants to impose a “penalty” on failed trades, which New York Fed Executive Vice President William Dudley said may cause U.S. borrowing rates to rise if not rectified. Yields indicate banks are less willing to lend than earlier in the year. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, widened to 216 basis points from 2008’s low of 76 basis points set in May. The spread increased to 464 basis points on Oct. 10, the most since Bloomberg began compiling the data in 1984. “The economic situation gets worse by the day,” said Adam Donaldson, head of debt research at Commonwealth Bank of Australia in Sydney, the nation’s second-largest lender by assets. “Yields can still drift lower.” Ten-year rates may drop to 3 percent by year-end, he said. Home Sales U.S. existing home sales fell 3.5 percent in October from the month before, after a 5.5 percent gain in September, based on the median forecast in a Bloomberg News survey. The National Association of Realtors will release the report today. The U.S. recession isn’t enough to revive the outlook for Treasuries, according to Ried, Thunberg & Co.’s weekly survey of fund managers. The firm’s sentiment index for the end of June fell to 40 for the seven days ended Nov. 21, from 41 the week before. A reading below 50 means investors anticipate lower prices. The 32 fund managers in the survey manage a combined $1.42 trillion. Ried Thunberg, based in Jersey City, New Jersey, is a unit of ICAP Plc, the world’s largest broker of trades between banks. To contact the reporters on this story: Gavin Finch in London at gfinch@bloomberg.net; Wes Goodman in Singapore at wgoodman@bloomberg.net.

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