By Bob Chen Dec. 23 (Bloomberg) -- Treasuries were little changed before a record auction of five-year notes today and a government report that economists estimate will show sales of new U.S. homes slumped to the lowest level in 17 years. Thirty- and 10-year securities led gains in December as investors sought higher yields. The Federal Reserve cut the benchmark interest rate to zero to 0.25 percent last week and said it may purchase longer-maturity debt to keep yields down, a so-called quantitative-easing policy. The difference in rates between two- and 10-year notes narrowed to 1.27 percentage points, the least since June. “The yield curve will flatten,” said Kevin Yang, who oversees $1 billion of Treasuries at Shinkong Life Insurance Co. in Taipei, Taiwan’s second-biggest life insurer. “The Fed will have quantitative easing because they want to lower longer-term Treasury rates.” The 10-year note yielded 2.18 percent as of 8:03 a.m. in London, according to BGCantor Market Data. The price of the 3.75 percent security due in November 2018 dropped about 2/32, or 63 cents per $1,000 face amount, to 113 29/32. The five-year note yield was at 1.42 percent. The Securities Industry and Financial Markets Association recommended a full closure for Treasuries in Japan today because of a public holiday and normal trade in the U.K. and U.S., according to its Web site. Five-Year Auction The U.S. will sell $28 billion of five-year notes today. A $38 billion auction of two-year debt yesterday drew a yield of 0.922 percent, the lowest ever. The bid-to-cover ratio, a gauge of demand, was 2.13, compared with an average of 2.25 at the last six auctions. The Federal Reserve cut its overnight target rate for lending between banks on Dec. 16 from 1 percent and said it would consider buying Treasuries in a policy known as quantitative easing. Treasuries returned 14.6 percent this year, the best annual performance since rising 18.5 percent in 1995, according to Merrill Lynch & Co.’s U.S. Treasury Master Index. Thirty-year bonds returned almost 18 percent in December compared with 7 percent in 10-year securities and 0.4 percent in two-year debt, Merrill indexes show. A deepening global recession and $1 trillion in writedowns and credit-market losses tied to U.S. mortgage securities drove investors to the relative safety of government debt. Money-Market Rates Two-year notes yielded 0.88 percent, after dropping to 0.645 percent last week, the lowest since regular sales began in 1975. Three-month Treasury bill rates were 0.02 percent after falling to minus 0.05 percent last week. Sales of new homes dropped to an annual pace of 415,000 in November, the lowest level since January 1991, according to the median estimate in a Bloomberg News survey before today’s report from the Commerce Department. Existing home sales fell 1 percent from a month earlier, after dropping 3.1 percent in October, a separate survey showed. A gauge of banks’ willingness to lend yesterday slipped below 150 basis points for the first time since the collapse of Lehman Brothers Holdings Inc. in mid-September amid speculation interest rates near zero and promises of more government cash will help thaw credit. The so-called TED spread, the difference between the London interbank offered rate, or Libor, that banks charge each other for three-month loans and Treasury bill rates, narrowed to 148 basis points, the lowest since Sept. 12, the last trading day before the Lehman collapse. The Treasury last auctioned five-year debt on Nov. 25, selling $26 billion at a yield of 2.11 percent. The bid-to-cover ratio was 2.44, compared with an average 2.29 at the previous six auctions. To contact the reporter on this story: Bob Chen in Hong Kong at bchen45@bloomberg.net

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