By Dakin Campbell and Gavin Finch Dec. 1 (Bloomberg) -- Treasuries rose, sending yields to record lows, before a report forecast to show U.S. manufacturing contracted in November at the fastest pace in 26 years. The yield on two-year notes fell as low as 0.94 percent and on the 10-year to 2.84 percent as European and Asian stock losses stoked demand for the safest assets. Yields will decline in 2009 as the Federal Reserve lowers its 1 percent target rate for overnight loans between banks to zero, JPMorgan Chase & Co. wrote in a report on Nov. 28. “It’s the economic outlook that’s moving the market,” 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 Fed. The central bank will “make a commitment to keep rates low for a period of time, and that is a signal for the market to take two-year notes down to a zero carry against funding.” The 10-year note yield fell eight basis points, or 0.08 percentage point, to 2.84 percent at 8:55 a.m. in New York, the least since Fed daily records started in 1962, according to BGCantor Market Data. It touched 2.78 percent in 1955 as measured on a monthly basis. The 3.75 percent security due November 2018 rose 24/32, or $7.50 per $1,000 face amount, to 107 26/32. The two-year note declined five basis points to 0.95 percent, after falling through 1 percent for the first time on Nov. 20. The 30-year bond yield dropped 10 basis points to a record 3.33 percent. ISM Manufacturing Demand for Treasuries strengthened as industrial production in China contracted by a record and Russia’s manufacturing shrank more in November than during the 1998 financial collapse. Europe’s Dow Jones Stoxx 600 Index dropped 3.1 percent, while the MSCI World Index lost 1.2 percent. U.S. stock futures fell. The Institute for Supply Management’s factory index decreased to 37, the lowest level since 1982, from 38.9 in October, according to the median estimate of 53 economists surveyed by Bloomberg News. A reading of 50 is the dividing line between expansion and contraction. “Risk aversion and the ongoing economic deterioration are keeping yields at these low levels,” said Peter Jolly, Sydney- based head of market research at NabCapital, the investment- banking unit of Australia’s largest lender. “With the economy slowing, that’s going to bring long-term yields down.” Ten-year yields will decline to 2 percent by the middle of next year and two-year rates will slide to 0.6 percent, JPMorgan analysts Terry Belton and Srini Ramaswamy in New York wrote in their report. Rate Expectations Futures on the Chicago Board of Trade show 76 percent odds the Fed will lower the rate by a half-percentage point from 1 percent on Dec. 16 and a 24 percent chance of a three-quarter percentage-point cut. Investors have flocked to Treasuries, sending them to their biggest monthly gain since 1981 last week, as the economy shrinks. President-elect Barack Obama, who assumes power in January, will inherit an economy that will contract 2.05 percent in the final quarter of 2008, a Bloomberg survey of banks and securities companies shows. The decline would be the biggest since 1990. General Motors Corp.’s board is meeting in Detroit to discuss a rescue plan that may determine if Chief Executive Officer Rick Wagoner can save the maker of Chevrolets and Buicks, people familiar with the plans said. Corporate Debt Hans Goetti, who oversees $10 billion in Asia as chief investment officer at LGT Bank in Liechtenstein (Singapore) Ltd., said he favors Treasury Inflation Protected Securities. The difference between rates on 10-year TIPS and conventional notes, reflecting the outlook among traders for consumer prices, was 34 basis points. The spread touched minus 8 basis points on Nov. 20, a level not seen since the introduction of inflation- protected securities in 1997. The difference fell from this year’s high of 268 basis points set in March. Yields on government debt dropped so low that fund managers have little chance of offering anything but subpar returns in 2009. U.S. government debt returned 10.1 percent on average this year, the most since 11.6 percent in all of 2002, Merrill Lynch & Co. index data show. BB&T Asset Management, BlackRock Inc., T. Rowe Price Group Inc. and Sage Advisory Services Ltd. are looking to invest in corporate debt they considered toxic just a month ago, including bonds of the banks that were almost ruined by almost $1 trillion in losses and writedowns. Treasury funds are receiving permission to buy debt of Morgan Stanley, JPMorgan Chase & Co. and Goldman Sachs Group Inc. after the Federal Deposit Insurance Corp. finalized plans on Nov. 21 to guarantee their debt. Yielding ‘Nothing’ Treasuries “are yielding next to nothing,” said Robert Millikan, who manages $5 billion at BB&T in Raleigh, North Carolina, including the $51 million BB&T Short U.S. Government Fund. “Trying to do something for your shareholders, it’s hard to sit there and buy a bond that yields less than any fees you charge.” European money-market rates climbed, indicating banks are less willing to lend, helping increase demand for government debt. The London interbank offered rate, or Libor, for three- month loans in dollars rose less than half a basis point to 2.22 percent today. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, widened to 218 basis points from 2008’s low of 76 basis points set in May. The spread was at 464 basis points on Oct. 10, the most since Bloomberg began compiling the data in 1984. To contact the reporters on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net; Gavin Finch in London at gfinch@bloomberg.net.

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