By Dakin Campbell and Lukanyo Mnyanda Dec. 11 (Bloomberg) -- Treasuries rose after a government report showed first-time claims for unemployment benefits surged last week to a 26-year high, fueling demand for government debt. U.S. securities extended five weeks of gains after Labor Department data showed initial jobless claims rose more than forecast to 573,000 in the week ended Dec. 6, from a revised 515,000 the previous week. The Treasury will sell $16 billion of 10-year notes today. One-month bill rates fell below zero for the first time after rates on three-month bills turned negative on Dec. 9. “We’ve seen the market rally to yields we never expected,” said Martin Mitchell, head government bond trader at the Baltimore unit of Stifel Nicolaus & Co. before the reports. “We’ll have to see how today’s 10-year auction goes and see if we get a breakout of this price action.” The yield on the benchmark 10-year note dropped four basis points, or 0.04 percentage point, to 2.66 percent at 8:40 a.m. in New York, according to BGCantor Market Data. The 3.75 percent security due in November 20018 gained 10/32, or $3.13 per $1,000 face amount, to 109 15/32. The two-year note yield fell four basis points to 0.83 percent. Treasuries of all maturities have returned 11.9 percent this year, according to Merrill Lynch & Co.’s U.S. Treasury Master Index, the best performance since the securities gained 13.4 percent in 2000. Financial Turmoil The notes surged this year with government bonds across the world as the U.S. housing slump pushed up the cost of credit globally, causing equity markets to tumble. Investors sought safety in government bonds as the world’s biggest financial companies incurred almost $1 trillion in writedowns and losses since the start of last year. Rates on one-month bills fell to minus 0.03 percent today, from 0.01 percent yesterday. The government sold $30 billion of the securities on Dec. 9 at zero percent for the first time since it began selling the securities in 2001. Three month bill rates fell to minus 0.01 percent two days ago and were unchanged today at 0.01 percent. The Treasury sold $27 billion of the three-month securities on Dec. 8 at a discount rate of 0.005 percent, the lowest since it started auctioning them in 1929. Bill Gross, manager of the world’s biggest bond fund, said he regrets not buying Treasuries after the rally pushed bill rates below zero. “If we went back 12 months and we had known then what we know now, it would have been all invested in Treasuries,” Pacific Investment Management Co.’s Gross said in a Bloomberg Television interview yesterday from Newport Beach, California. Yield Spread The difference in yield, or spread, between two- and 10- year notes was 1.86 percentage points, the widest this month and down from a five-year high of 2.62 percentage points on Nov. 13. Some investors are turning to longer-term notes amid speculation consumer prices will drop and as short-term notes yield less than one percent. “Deflationary pressures will occur in the coming quarter,” said Hiromasa Nakamura, a senior investor in Tokyo at Mizuho Asset Management Co., which has $41.9 billion in assets. “The yields will decline further in accordance with the yield- curve flattening.” The $5.3 trillion market for U.S. government debt may be a bubble waiting to burst, according to analysts and investors. Treasuries have “absolutely” entered a bubble, said David Brownlee, who oversees $15 billion as head of fixed income at Sentinel Asset Management in Montpelier, Vermont. “There is very little rationality in my mind to bills trading at zero.” 10-Year Sale Investors should keep buying bonds as the economic slump deepens and the 10-year yield may drop to 2.5 percent before the end of the year, Schnautz said. Gains in debt may be tempered before the Treasury’s 10-year note auction today, part of record debt sales to fund U.S. financial rescues. The Treasury sold $20 billion of the securities on Nov. 12 at a high yield of 3.783 percent, down from as high as 5.21 percent at a sale in June 2007. A $28 billion auction of three-year securities yesterday drew less demand than the previous auction. Lower demand for government securities “will continue,” 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. “The current environment has almost no participants because it’s close to year-end. It may improve in January.” $2 Trillion Private analysts estimate the government’s borrowing needs may reach $1.5 trillion to $2 trillion in the 12 months through Sept. 30, 2009, Treasury Assistant Secretary Karthik Ramanathan said yesterday. The “Treasury needs to be prepared to meet additional financing needs if necessary,” Ramanathan said in New York. Public spending and a slowing economy will require “conventional” ways to raise money, such as increasing the size and frequency of debt issuance, selling cash-management bills when short-term funds run low and reintroducing securities when necessary, he said. The U.S. budget deficit swelled to $164.4 billion in November, the second straight month it widened, the Treasury Department said yesterday. The shortfall was $98.2 billion a year earlier. To contact the reporters on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net; Lukanyo Mnyanda in London at lmnyanda@bloomberg.net.

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