By Susanne Walker and Paul Dobson May 25 (Bloomberg) -- Treasuries rose, leading benchmark government bond markets higher, as concern Europe’s debt crisis is spreading and tension between North and South Korea boosted the refuge appeal of sovereign debt. The yield on the 10-year Treasury note dropped to its lowest in more than a year as stocks slid and the euro weakened after the International Monetary Fund urged Spain to take more steps to overhaul ailing banks. 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. “It’s a riot,” said David Ader, head of government bond strategy at Stamford, Connecticut-based CRT Capital Group LLC. “We are seeing a seismic shift out of risky assets and into more risk-free assets.” “The trigger today is the Korea story, which has weighed heavily on the Asian equity markets,” said Kornelius Purps, a fixed-income strategist at UniCredit SpA in Munich. “We also have increasing concern about the Spanish banking sector, which is weighing on yields. It’s consistent that we see Treasuries firm, equities weak and the euro down.” The yield on the 10-year note fell 7 basis points to 3.13 percent at 7:55 a.m. in New York after reaching 3.06 percent, according to BGMarket Cantor Data. That’s the lowest since April 29, 2009. The 3.5 percent security due May 2020 rose 19/32, or $5.94 per $1,000 face amount, to 103 6/32. The 30-year yield fell 6 basis points to 4.03 percent. German 10-year bund yields dropped 8 basis points to a record low of 2.57 percent. Yields on two-year gilts dropped near a six-month low of 0.83 percent. Euro Slides The euro slid 1.4 percent to $1.2202, approaching the four- year low of $1.2144 set May 19. The MSCI Asia Pacific Index of shares fell 3.1 percent, the Stoxx Europe 600 Index fell 3.2 percent and Standard & Poor’s 500 Index futures expiring next month dropped 2.5 percent. Treasuries have returned 2 percent this month, the most since a 2.3 percent gain in March 2009, Bank of America Merrill Lynch indexes show. Concern that the region’s economy will slump as the European Union tries to head off the Greek debt crisis helped send the U.S. 10-year note yield tumbling from the 2010 high of 4.01 percent it reached on April 5. Spain’s banking industry “remains under pressure” as consolidation has been “too slow,” the Washington-based IMF said in a report yesterday after a regular review of Spain. Four Spanish savings banks said yesterday they submitted a proposal to Spain’s central bank to pool their businesses. ‘Amplifying Shocks’ “Banks have a way of amplifying shocks in the system,” Mohamed A. El-Erian, co-chief investment officer at Pacific Investment Management Co., which runs the world’s biggest mutual fund, 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.” The rate banks say they pay for three-month loans in dollars climbed for the 11th day as concern mounted that Europe’s debt crisis will prompt financial institutions to question one another’s creditworthiness. The London interbank offered rate, or Libor, for such loans advanced to 0.536 percent, the highest level since July 7, from 0.510 percent yesterday, according to data from the British Bankers’ Association. The dollar Libor-OIS spread, a gauge of banks’ reluctance to lend, widened to the most since July 16. Asian Stocks Asian equities dropped, boosting demand for the safety of U.S. fixed-income assets, on a report by Yonhap News that said North Korea’s military was ordered to prepare for combat following South Korea’s announcement that the nation torpedoed one of its warships. The two-year notes being offered today yielded 0.74 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. Auction Demand “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 Royal Bank of Canada in New York, wrote in a report yesterday. U.S. Treasury Secretary Timothy F. Geithner said in Beijing today that Europe needs to revamp its fiscal policies to avoid crises like the one triggered by Greece’s budget woes. The European Union faces “the difficult challenge of trying to restore sustainability to an unsustainable system,” Geithner said. “Europe’s leaders recognize that and now are acting forcefully to put strong reforms in place.” Data today will probably show home prices and consumer confidence improved, economists said before the reports. The S&P/Case-Shiller index of property values in 20 cities rose 2.5 percent in March from a year earlier, the best performance since 2006, according to the median forecast of 26 economists surveyed by Bloomberg News. Signs the economy is beginning to create jobs may have lifted Americans’ spirits in May for a third consecutive month, another report may show. To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net; Paul Dobson in London at pdobson2@bloomberg.net;

Source