By Cordell Eddings and Susanne Walker May 15 (Bloomberg) -- U.S. two-year notes had their first three-week winning streak since January as demand for the safest assets rose on speculation Europe’s sovereign-debt crisis will damp growth and lead to disintegration of the euro. Treasuries, which fell the most in nine months May 10 after European leaders announced an almost $1 trillion bailout plan, climbed yesterday even as reports showed America’s economic recovery is building momentum. The euro dropped to its weakest level since 2008, and stocks plunged. A report next week is forecast to show U.S. consumer prices rose 0.1 percent in April. “There is a flight to quality emanating from the issues coming from Europe and the viability of their monetary union going forward,” said Christopher Sullivan, who oversees $1.6 billion as chief investment officer at United Nations Federal Credit Union in New York. “The market has looked past the short-term liquidity solution of last weekend and is looking to the long-term structural issues.” Two-year note yields fell 3 basis points to 0.79 percent, the lowest weekly close since Feb. 5, according to BGCantor Market Data. The 1 percent security due in April 2012 increased 1/32, or 31 cents per $1,000 face amount, to 100 13/32. A basis point is 0.01 percentage point. U.S. 10-year note yields were at 3.45 percent after trimming a rise for the week to 3 basis points. They gained as much as 18 basis points May 10, the most since August, on the bailout package and fell as much as 12 basis points yesterday. Yield Curve The difference between yields on 2- and 10-year notes, known as the yield curve, widened to 2.67 percentage points from 2.62 percentage points on May 7. The Treasury sold $78 billion of 3-, 10- and 30-year securities this week, drawing bids for more than two and a half times the amount on offer at each auction. The European Union’s failure to ease concern some of its nations may default has boosted demand for U.S. securities. The U.S. 10-year note yield touched 3.26 percent May 6, the lowest since Dec. 2, from an 18-month high of 4.01 percent April 5. Treasuries were the world’s top-performing bonds in the past month. U.S. notes due in 10 years and longer gained 3.8 percent on average in the past month, the most of 174 bond indexes after accounting for currency rates, according to data compiled by Bloomberg. ‘Very Serious Situation’ The euro dropped to $1.2354 yesterday, the weakest level since October 2008, as German Chancellor Angela Merkel said Europe is in a “very, very serious situation” even with the bailout package. The Standard & Poor’s 500 Index tumbled 1.9 percent yesterday, paring a weekly rally. Deutsche Bank AG Chief Executive Officer Josef Ackermann said in an interview with ZDF television that Greece, where the crisis began, may not be able to repay its debt in full without “incredible efforts.” Lending between banks has faltered as the crisis has deepened. The dollar London interbank offered rate-OIS spread, a gauge of banks’ reluctance to lend, widened to 22 basis points, from 18 basis points on May 7. Libor, the rate banks say they pay for three-month loans in dollars, rose yesterday to 0.445 percent, the most since Aug. 12, from 0.436 percent on May 13, according to data from the British Bankers’ Association. Morgan Stanley, the most bearish interest-rate forecaster of all the 18 primary dealers that trade with the Federal Reserve, reduced its year-end estimate on May 10 for the yield on Treasury 10-year notes due to euro area concerns. Not Just U.S. Story “On the domestic front, things have gotten a lot better, but the U.S. rates story is more than a U.S. story, given the intensity of the sovereign crisis,” said Richard Berner, co- head of global economics in New York. “Higher real rates due to massive borrowing needs and increasing private credit demand will still be the case. What has happened in the sovereign-debt space has reset the clock for risk assets globally.” U.S. 10-year yields will end the year at 4.5 percent, down from a previous estimate of 5.5 percent, according to revised forecasts issued by Berner and David Greenlaw, Morgan Stanley’s chief fixed-income economist in New York. Retail sales and industrial production in the U.S. climbed more than forecast in April, indicating the economic recovery gained momentum at the start of the second quarter. Sales rose 0.4 percent, after a 2.1 percent gain in March that was larger than previously estimated, a Commerce Department report showed yesterday in Washington. Output at U.S. factories, mines and utilities rose 0.8 percent, the most in three months, data from the Fed showed. “Global uncertainties are overwhelming any domestic economic story,” Larry Milstein, managing director in New York of government and agency debt trading at R.W. Pressprich & Co., a fixed-income broker and dealer for institutional investors, said. “You don’t want to be short Treasuries right now.” A short position is a bet a security will fall. Consumer prices rose 0.1 percent in April, the same as in March, according to the median forecast of 59 economists in a Bloomberg survey. The Labor Department reports the data May 19. To contact the reporters on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Susanne Walker in New York at swalker33@bloomberg.net

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