Treasuries rose, sending 10-year notes to their first gain in four days, before a government report that economists say will show U.S. housing starts fell to a record low. Government securities also gained as 10-year yields offered about 2.43 percentage points more than the pace of inflation, the most in 16 months. Deutsche Bank Securities Inc., Merrill Lynch & Co. and Mizuho Securities Co. are all telling clients to prepare for deflation as the economic recession spreads. “Economic weakness is extreme and is going to remain extreme,” said Adam Donaldson, Sydney-based head of debt research at Commonwealth Bank of Australia, the nation’s second- largest lender by assets. “The major concerns will center around deflation over the next year. That is going to support Treasuries.” The 10-year yield declined one basis point to 2.53 percent as of 2:01 p.m. in Tokyo, according to BGCantor Market Data. The price of the 3.75 percent security maturing in November 2018 rose 1/8, or $1.25 per $1,000 face amount, to 110 17/32. A basis point is 0.01 percentage point. The rate may slide to less than 2 percent in the next few months, Donaldson said, surpassing the record low of 2.04 percent set Dec. 18. Deutsche Bank and Merrill Lynch, both in New York, and Tokyo-based Mizuho each issued reports over the past week saying the risk of deflation is increasing. A general decline in prices for goods and services enhances the value of the fixed payments from bonds. ‘Very Compelling’ Long-term Treasuries are “very compelling,” wrote David Rosenberg, Merrill Lynch’s North American economist. All three companies are among the 17 primary dealers that underwrite U.S. government debt. The difference between rates on 10-year notes and Treasury Inflation Protected Securities, which reflects the outlook among traders for consumer prices, was 60 basis points. The figure, which averaged 1.78 percentage points for the past year, was as low as minus eight basis points in November. Housing starts probably fell to an annual rate of 605,000 last month, the lowest level since the Commerce Department started compiling data in 1959, according to the median estimate in a Bloomberg News survey of economists. Initial jobless claims rose last week, a separate report will show, based on a separate Bloomberg survey. Both figures are scheduled for 8:30 a.m. in Washington. Increasing Sales Yields were still close to a two-week high because of speculation President Barack Obama will increase debt sales to record levels as he combats the recession. Obama’s economic team is trying to complete a bank-rescue plan that can be implemented along with an $825 billion stimulus package being negotiated with Congress, people familiar with the deliberations said. Some parts of the credit markets indicate government efforts to spur growth, including a $700 billion plan approved by former President George W. Bush, are starting to work. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, narrowed to 1.02 percentage points from 2008’s high of 4.64 percentage points in October. The London interbank offered rate, or Libor, for three- month dollar loans was 1.125 yesterday, down from 4.82 percent in October. Bank bailout plans in the U.S. and the U.K. are leading investors to buy contracts that provide insurance on the debt of the two nations, said Hideo Shimomura, chief fund investor at Mitsubishi UFJ Asset Management Co. in Tokyo. Default Swaps Credit-default swaps covering five-year U.S. securities rose to 60 basis points, the highest since Bloomberg started tracking the data. That means an investor would need to pay a record $60,000 to protect $10 million of debt. For the U.K., the contract rose to 1.47 percentage points, the most ever, from 1.07 percentage points at the start of the year, according to data compiled by Bloomberg. Credit-default swaps, which protect against or speculate on default, pay the buyer face value if a company fails to adhere to its debt agreements. “The government’s credit risk is rising” in the two nations, said Shimomura, who oversees $4 billion in non-yen bonds at the unit of Japan’s largest bank. “The deficit situation is becoming worse.” Economists at Goldman Sachs Group Inc. in New York, another primary dealer, predict Treasury borrowing will rise to a record $2 trillion this fiscal year ending Sept. 30, compared with $892 billion in notes and bonds sold during the last fiscal year. Job Losses The Treasury is scheduled to announce today the size of two- and five-year notes and 20-year Treasury Inflation Protected Securities it plans to sell next week. Notes rose today as the recession spread. Williams-Sonoma Inc., the U.S. cookware retailer based on San Francisco, said yesterday it will cut 1,400 jobs. The U.S. economy won’t start growing again until the second half of 2009, a Bloomberg survey of banks and securities companies shows. Japan’s exports fell a record 35 percent in December from a year earlier. China’s economy grew at the slowest pace in seven years, while South Korea’s shrank. Asian companies are slashing plans to borrow for expansion and acquisitions as the global credit crisis deepens, according to a survey of more than 500 regional treasurers and finance directors by Greenwich Associates, a market research company based in Stamford, Connecticut.

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