Treasury three-year notes fell before a record $30 billion auction of the securities. U.S. bonds of all maturities declined on concern President- elect Barack Obama will drive debt sales to unprecedented levels as the government boosts spending and cuts taxes to spur economic growth. The U.S. will offer $16 billion of 10-year securities tomorrow. “Over the past few days we’ve seen a big cheapening of bond markets,” said David Keeble, head of fixed-income strategy in London at Calyon, an investment-banking unit of Credit Agricole SA. “It’s a very difficult time to be selling bonds as a government.” The two-year yield rose four basis points to 0.82 percent as of 7:23 a.m. in New York, according to BGCantor Market Data. The price of the 0.875 security maturing in December 2010 fell 2/32, or 63 cents per $1,000 face amount, to 100 4/32. Ten-year yields were also up three basis points at 2.49 percent. Three-year yields increased four basis points to 1.11 percent, having declined from 1.25 percent the last time the securities were sold on Dec. 10. Investors bid for 2.15 times the amount of debt on offer last month, versus the average of 2.41 for the past 10 sales of the securities. A Treasury auction of $8 billion in inflation-indexed notes yesterday drew the most demand in nine years, indicating investors are concerned that inflation will quicken along with government spending. The sale drew a yield of 2.245 percent. Bids amounted to 2.48 times the available debt, the highest since 2000. ‘Shorting’ “One of our favored plays for 2009 is to set longs in inflation by shorting conventional paper into inflation-linked paper,” Padhraic Garvey, head of investment-grade debt strategy in Amsterdam at ING Groep NV, wrote today in an e-mailed note titled “Inflation-Linked Bonds Are Back.” Inflation erodes the value of interest payments on fixed- income instruments. The cost of protecting bonds from default dropped in Europe and Asia, according to traders of credit-default swaps. Contracts on the Markit iTraxx Crossover Index of 50 companies with mostly high-risk, high-yield credit ratings declined nine basis points to 975, according to JPMorgan Chase & Co. prices. Credit-default swaps are contracts to protect against or speculate on default, and a decrease indicates improvement in perceptions of credit quality. Yields also suggest banks are becoming more willing to lend. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, narrowed to 1.27 percentage points from 2008’s high of 4.64 percentage points in October. T-Bill Yields Three-month bill yields indicate declining demand for the securities, seen as among the safest investments because of their short maturity. The rate rose to 0.13 percent, near a seven-week high. A Merrill Lynch & Co. index of U.S. corporate bonds yielded 7.70 percentage points more than Treasuries, narrowing from 8.96 percentage points in the middle of December. “Bond markets remain at risk,” said Charles Diebel, head of European interest-rate strategy in London at Nomura International Plc. “A sentiment bounce over the first quarter could be good for riskier assets such as equities and commodities and equally bad for bond markets.” Bond bulls say the demand for safety that sent Treasuries surging in 2008 will last in 2009 as the economy contracts. International Business Machines Corp., the biggest technology employer, may cut thousands of jobs this month, according to the employee group Alliance for IBM. Long Bonds The Federal Reserve will help keep the rally going by buying long-term Treasuries to keep borrowing costs down, said Akira Takei, the head of non-yen bonds at Mizuho Asset Management Co. in Tokyo. Fed Chairman Ben S. Bernanke said Dec. 1 the central bank may use Treasury purchases to help revive the economy. U.S. 10-year yields will fall to 1.50 percent by year-end, said Takei, who helps oversee the equivalent of $42.5 billion at the unit of Japan’s second-largest bank. “The Fed will start buying bonds before the end of March,” he said. Takei, who correctly predicted Treasuries would rally in 2007 and 2008, said he is favoring 30-year bonds this year. The so-called long bonds yield 3.04 percent, or 2.23 percentage points more than two-year notes, near the most in three weeks. President-elect Obama said yesterday he expects to inherit a $1 trillion budget deficit and that similar shortfalls are in store “for years to come” as the government grapples with a recession and other spending demands. The deficit was a record $455 billion in fiscal 2008, more than double the gap a year earlier. The 2009 fiscal year runs through Sept. 30.

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