By Wes Goodman May 20 (Bloomberg) -- Treasuries rose, rebounding from a loss yesterday, as declines in shares and the euro increased demand for the relative safety of U.S. debt. Yields indicate traders cut bets on inflation to the lowest level in six months before an industry report that economists said will show the U.S. expansion is losing momentum. The euro weakened against the dollar on concern the pace of Europe’s economic recovery will wane as governments combat a debt crisis with spending cuts. “The flight to quality is still on,” said Yusuke Tanaka, a senior dealer in Singapore at Mitsubishi UFJ Trust & Banking Corp., a unit of Japan’s largest publicly traded bank. “Europe will not be able to solve its problems quickly.” The yield on the benchmark 10-year note fell two basis points to 3.35 percent as of 7:41 a.m. in London, according to BGCantor Market Data. The 3.5 percent security due May 2020 rose 5/32, or $1.56 per $1,000 face amount, to 101 1/4. The euro fell 0.4 percent to $1.2361, approaching a four- year low set yesterday. Germany’s decision May 18 to ban naked short sales of sovereign debt sent the currency to the lowest since April 2006. MSCI’s World Index of shares fell 0.3 percent, declining for a sixth day. The MSCI Asia Pacific Index slid 1.7 percent. Inflation wagers tumbled after a government report yesterday showed the cost of living in the U.S. dropped in April for the first time in more than a year. Declining prices in the economy combined with the debt crisis in Europe are reinforcing forecasts for the Federal Reserve to keep its benchmark interest rate at a record low this year. ‘Good for Bonds’ “The U.S. will have disinflation,” said Tsutomu Komiya, who handles U.S. government debt in Tokyo at Daiwa Asset Management Co., which has $77 billion in assets. “It’s good for bonds. The situation in Europe may depress U.S. economic growth.” Komiya cut his forecast for 10-year yields to 3.5 percent by the end of June, from 3.75 percent. The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, a gauge of trader expectations for consumer prices, shrank to as low as 2.06 percentage points today, the least since Nov. 4. Futures on the CME Group Inc. exchange show a 39 percent chance U.S. policy makers will raise their benchmark rate by at least a quarter percentage point this year, down from a 58 percent possibility a month ago. Policy makers have kept their target for overnight loans between banks in a range of zero to 0.25 percent since December 2008. Spread Narrows The difference between two- and 10-year yields narrowed to 2.58 percentage points yesterday, within three basis points of the lowest level this year. Two-year notes tend to track the Fed’s benchmark because of their short maturities, while longer- term bonds are more influenced by inflation. The Treasury is scheduled to announce today how much it plans to sell in two-, five- and seven-year notes next week. Its auctions of these securities a month ago totaled $118 billion. The Conference Board’s index of U.S. leading indicators probably rose 0.2 percent in April, the smallest gain since March 2009, according to a Bloomberg News survey. Other reports today will show jobless claims were little changed last week and manufacturing in the Philadelphia region expanded this month, separate Bloomberg surveys show. Consumer Prices The consumer price index fell 0.1 percent in April from March, the Labor Department reported yesterday. The risk of deflation has increased because of the economic crisis sweeping Europe, said Ward McCarthy, chief financial economist at primary dealer Jefferies & Co. Inc. in New York. “We do not have any inflation pressure of note,” McCarthy said yesterday in an interview on Bloomberg Radio with Tom Keene. “We have seen some disinflation actually since the beginning of the year. It could evolve into deflation.” Deflation is a general drop in prices. Disinflation is a slowing of price increases. Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., increased holdings of U.S. government-related debt last month to the most since November, the company reported yesterday. The $224.5 billion Total Return Fund’s investment in government-related debt, which includes Treasuries, was boosted to 36 percent of assets in April, from 33 percent the previous month, according to the website of Newport Beach, California- based Pimco. Non-U.S. developed-market debt accounted for 13 percent, down from 18 percent in March and the least since the securities composed 5 percent of assets in November. U.S. government debt due in 10 years and longer returned 6.1 percent in the past month after accounting for gains in the dollar, the most of 174 bond indexes around the world, according to data compiled by Bloomberg. To contact the reporters on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.

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