By Wes Goodman May 25 (Bloomberg) -- Treasuries rose, pushing yields toward the lowest level in a year, as the euro weakened and tensions between North and South Korea increased. Notes gained for a second day after two-year swap spreads widened by the most in 15 months on concern Europe’s sovereign debt crisis will slow global economic growth. The U.S. is scheduled to auction $42 billion of two-year securities today, and market rates indicate the auction yield may decline to a record low. “Economic conditions may suffer” because of Europe’s credit crunch, said Hideo Shimomura, who helps oversee the equivalent of $55.5 billion as Tokyo-based chief investor at Mitsubishi UFJ Asset Management Co., a unit of Japan’s biggest bank. “People are looking for ‘safety sovereigns,’” such as U.S. Treasuries. The yield on the 10-year note fell five basis points to 3.15 percent as of 6:46 a.m. in London, according to data compiled by Bloomberg. The 3.5 percent security due May 2020 rose 14/32, or $4.38 per $1,000 face amount, to 103 1/32. The yield dropped to 3.10 percent May 21, the lowest since May 2009. The euro slid 0.7 percent to $1.2287, approaching the four- year low of $1.2144 set May 19. Strains in Spain’s banks are intensifying concern the Greek debt crisis may spread, Mohamed A. El-Erian, whose company runs the world’s biggest mutual fund, said in an interview with PBS. ‘Amplifying Shocks’ “Banks have a way of amplifying shocks in the system,” El-Erian, co-chief investment officer at Pacific Investment Management Co., said on PBS’s Nightly Business Report on the U.S. public broadcaster’s website. Banks are “like the oil in your car. They link up so many different parts.” Treasuries also rose as the MSCI Asia Pacific Index of shares dropped to the lowest since July after a report that North Korea’s military had been ordered to prepare for combat. The Korean won slumped 3.7 percent to 1,259.53 per dollar, and the cost of insuring South Korean government debt from default surged to a 10-month high. Credit-default swaps on South Korea jumped 10 basis points to 153 basis points, according to CMA DataVision. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations. North Korean leader Kim Jong Il ordered the military to get ready for combat in a message televised nationwide last week, following South Korea’s announcement that his nation torpedoed one of its warships. The message was broadcast on May 20, according to the website of North Korea Intellectuals Solidarity, a Seoul-based group run by defectors from the communist country. Yonhap News reported on the posting today. Swap Spreads The two-year swap spread widened 10.5 basis points yesterday to 52.25 basis points yesterday, the biggest increase since Feb. 10, 2009. A basis point is 0.01 percentage point. In a swap, investors exchange fixed- and floating-rate obligations. The spread is the difference between the fixed rate and the yield on same-maturity Treasuries. Yields indicate banks have become less willing to lend because of the European crisis. The London interbank offered rate, which banks pay for three-month loans in dollars, rose to 0.51 percent yesterday, the highest level since July, according to the British Bankers’ Association. The extra yield Libor offers over the overnight indexed swap rate, the Libor-OIS spread, widened to 29 basis points today, also the most since July. Libor to Climb Libor may climb to 1.50 percentage points over the next several months, driven by Europe’s credit crisis and financial regulatory reform, Neela Gollapudi, a strategist at Citigroup Global Markets Inc. in New York, wrote in a report May 21. U.S. lawmakers are working on a bill to revise U.S. financial regulations. Citigroup is one of the 18 primary dealers that are required to bid at the government debt sales. The two-year notes being offered today yielded 0.77 percent in pre-auction trading, compared with 1.024 percent at the previous sale April 27. The lowest yield on record for a two- year auction was 0.802 percent on Nov. 23, according to Treasury Department data. Investors bid for 3.03 times the amount on offer last month versus an average of 3.09 for the past 10 sales. Indirect bidders, the category of investors including foreign central banks, purchased 31 percent of the notes, versus the 10-sale average of 41.4 percent. Direct bidders, non-primary dealers that place their orders directly with the Treasury, bought 21.4 percent, up from the 10-sale average of 12.4 percent. The U.S. is also scheduled to auction $40 billion of five- year securities tomorrow and $31 billion of seven-year debt on May 27. The total of $113 billion is down from the $118 billion when this combination of securities was sold last month. “Our expectation is that the auctions will find support as global uncertainty is still the story of the day,” Keith Blackwell and Dan Grubert, analysts at primary dealer RBC Capital Markets Corp. in New York, wrote in a report yesterday. To contact the reporters on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.

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