By Liz Capo McCormick and Gavin Finch Nov. 28 (Bloomberg) -- Treasuries were little changed, headed for their biggest monthly gain since Ronald Reagan was in the White House, as President-elect Barack Obama said the U.S. faces a “time of great trial” and the economy shrinks. The gains drove 10-year yields to a record low of 2.91 percent after reports this week showed durable-goods orders fell more than twice as fast as forecast, consumer spending dropped the most since 2001 and the economy shrank in the third quarter more than first estimated. Traders bet the Federal Reserve will cut its benchmark interest rate by at least a half-percentage point on Dec. 16 to limit the slump, futures contracts show. “The primary driver behind the fall in Treasury yields this month was the deterioration in the economy and the sinking realization that deflation could be a factor of life going forward,” said Bulent Baygun, head of interest-rate strategy in New York at BNP Paribas Securities Corp., one of the 17 primary dealers that trade government securities with the Fed. The yield on the 10-year note was 2.98 percent at 9:45 a.m. in New York, according to BGCantor Market Data. The 3.75 percent security due in November 2018 traded at 106 19/32. The yield on the two-year note was 1.12 percent. It dropped below 1 percent on Nov. 20, the lowest since regular sales began in 1975. ‘Decent Returns Ahead’ “Bullish bond-market sentiment persists on growing signs the economic recession is deepening while the outlook for inflation improves,” said Nick Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets. “There are still decent returns ahead, though possibly not on the scale we’ve seen this month.” Ten-year yields will sink to 2.75 percent by the end of the year, Stamenkovic said. Futures on the Chicago Board of Trade show 66 percent odds the Fed will lower the target overnight lending rate between banks by a half-percentage point from 1 percent on Dec. 16 and a 34 percent chance of a three-quarter percentage point cut. The 10-year yield touched the least today since the Fed’s daily records on the note began in 1962 and since 1958 on a monthly basis. Investors have piled into longer-dated debt on speculation the contracting economy will subdue inflation, flattening the so-called yield curve. The difference in yield, or spread, between two- and 10-year notes narrowed to 1.86 percentage points, from 2.62 percentage points on Nov. 13, a five-year high. Buying Bills Bonds rallied this week after the U.S. announced a plan to buy as much as $600 billion of mortgage securities, spurring demand for U.S. securities as a replacement for bonds backed by home loans that may be repaid early. “It will take the hard work, innovation, service and strength of the American people” to end the financial crisis, Obama said yesterday in his weekly radio address. Investors seeking the safest assets pushed yields on three- month Treasury bills to 0.04 percent after the government pledged to revive lending to consumers and rescued Citigroup Inc. The yield dropped to 0.01 percent on Nov. 21, the lowest level since the 1940s, according to monthly figures from the central bank. U.S. notes and bonds may gain on speculation investors will buy notes to match changes in benchmark indexes as the gauges adjust to include debt sold this month. The Treasury holds its quarterly auctions of notes and bonds in February, May, August and November. Treasury Returns Treasuries returned 5.07 percent this month, the most since October 1981, when former Fed Chairman Paul Volcker was battling to tame inflation that was running at more than 10 percent. Obama this week appointed Volcker, 81, to head a new White House economic board that will propose ways to revive growth. German bonds handed investors 3.8 percent this month and Japanese government securities 0.4 percent. Corporate debt in the U.S. and Europe rose the most since 2003 in November, luring investors with record yield spreads relative to government securities. 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, known as the TED spread, was at 2.18 percentage points today. The spread, which reached a low this year of 76 basis points in May, was at 4.64 percentage points on Oct. 10, the most since Bloomberg began compiling the data in 1984. The Standard & Poor’s 500 Index fell 0.1 percent after posting its steepest four-day increase since 1933. ‘Rally May Pause’ “We don’t think Treasuries are attractive,” said Shuhei Mochizuki, Tokyo-based assistant manager in the foreign bond section at Sumitomo Life Insurance Co., which has the equivalent of $31.5 billion in non-Japanese debt. “After yields fell in November, they don’t offer good value. The rally may pause.” A Bloomberg survey of banks and securities companies shows 10-year yields will increase to 3.56 percent by year-end. The most recent forecasts are given the heaviest weightings. Trading volumes may be lower than usual today. The Securities Industry and Financial Markets Association recommended trading stop at 2 p.m. in New York, after the market was closed yesterday for the Thanksgiving holiday in the U.S. To contact the reporters on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net; Gavin Finch in London at gfinch@bloomberg.net.

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