Treasuries rose, heading for their biggest annual gain since 1995, before an industry report that economists estimate will show U.S. home prices plunged by the most on record. The world’s largest economy may experience a “whiff of deflation” next year, analysts at Deutsche Bank Securities Inc. in New York wrote today. Government debt returned 14.7 percent in 2008, according to Merrill Lynch & Co.’s U.S. Treasury Master index, as a housing slump triggered a recession and led to $1 trillion of losses at the world’s biggest financial companies. “The Treasuries seem to be driven by a market consensus of a prolonged recession and disinflation,” said Lena Komileva, head of market economics in London at Tullett Prebon Plc, the second biggest broker of transactions between banks. “But we’ve come to a point where bonds are overbought and equities are oversold. I expect to see a very cautious return in interest toward good-quality, high-yield bonds away from government debt next year.” The 10-year yield fell two basis points to 2.09 percent at 10:55 a.m. in London, according to BGCantor Market Data. The 3.75 percent note maturing November 2018 rose 5/32, or $1.56 per $1,000 face amount, to 114 25/32. The yield may rise to 2.79 percent in the second quarter and to 3.40 percent by the end of next year, according to a median forecast by 57 economists in a Bloomberg survey. Two-year yields declined two basis points to 0.76 percent. Three-month yields fell 5 basis points to 0.01 percent. Economists surveyed by Bloomberg forecast the two-year yield will rise to 1.59 percent next year. House Prices Home prices slid 17.9 percent in October from a year earlier, the biggest decline since records began in 2001, according to a Bloomberg survey of economists before the S&P/Case-Shiller index. Separate reports today will show U.S. consumer confidence improved and business around Chicago slowed, according to Bloomberg News surveys of economists. “There are major deflationary downdrafts,” in the economy, Deutsche Bank economists Joe LaVorgna and Carl Riccadonna in New York wrote in their report. “We do not believe there’s a Treasury note bubble at present, but rather yields are reflecting a reduced inflation premium.” Deutsche Bank, one of the 17 primary dealers that underwrite U.S. debt, predicts 10-year yields will be about 2 percent in the first half of 2009. Deflation, a general drop in prices, helps Treasuries by enhancing the value of their fixed payments. No Inflation U.S. yields indicate traders expect almost no inflation for the next decade. The difference between yields on 10-year Treasury Inflation Protected Securities, or TIPS, and conventional notes, which reflects the outlook among traders for consumer prices, was 0.08 basis point. The spread was a negative 0.08 basis point in November, the least since Bloomberg data started in 1998. The U.S. economy will contract one percent next year, while consumer prices will rise by 0.65 percent in 2009, according to Bloomberg surveys of economists. The government needs to finance a bailout of the banking system and an economic stimulus plan that members of President- elect Barack Obama’s transition team said may cost $850 billion. Obama has expanded his economic stimulus goals and called for creating or saving 3 million jobs over the next two years. The U.S. Treasury committed yesterday $6 billion to support GMAC LLC, the financing arm of General Motors Corp. The loan is in addition to $13.4 billion the Treasury agreed earlier this month for GM and Chrysler LLC. Debt Supply The Treasury Department estimated it will sell as much as $2 trillion of debt this fiscal year, which began Oct. 1. U.S. marketable debt climbed to a record $5.82 trillion in November from $4.54 trillion a year earlier. Some investors are looking for higher yields outside of the sovereign debt market. “Government bond interest rates are nearly zero,” said Tsutomu Komiya,’’ an investor in Tokyo at Daiwa Asset Management Co., a unit of Japan’s second-largest brokerage, which has the equivalent of $107.5 billion in assets. “That level is not attractive.” Komiya is considering investing in debt issued by Fannie Mae and Freddie Mac, the two largest U.S. providers of mortgage financing that the government seized in September. He may also buy bonds sold by the World Bank, which makes loans to developing countries, he said. Fannie’s 10-year debt yielded 79 basis points more than Treasuries, versus 52 basis points at the end of 2007, according to data compiled by Bloomberg. Buy Corporates Alliance Bernstein Japan Ltd., part of New York-based money manager AllianceBernstein Holding LP, is recommending U.S. company debt. “Corporate bond spreads look relatively cheap,” said Noriko Miyoshi, director of fixed income for the firm in Tokyo. Yields show banks are more 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, narrowed to 1.45 percentage points from 2008’s high of 4.64 percentage points in October. Singapore’s three-month interbank rate for U.S. funds slipped one basis point to 1.45 percent, the lowest since 2004. Hong Kong’s local currency rate, three-month Hibor, was little changed at 1.00 percent, the lowest since 2005. Treasuries extended gains from yesterday when traders sought the safety of U.S. government debt amid fighting in the Middle East and a drop in stocks. The MSCI World Index of shares rose 0.3 percent, gaining for a fourth day, and Standard & Poor’s 500 Index futures expiring in March climbed 0.7 percent, advancing for a fourth day. Yields on two-year notes were 1.33 percentage points below 10-year Treasury yields as investors sought a haven in short- term debt. The gap was 2.62 percentage points on Nov. 13, when investors were betting the Federal Reserve would reduce its target rate for overnight bank lending. The Fed lowered the benchmark to a range of zero to 0.25 percent, from 1 percent, on Dec. 16.

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