By Wes Goodman June 30 (Bloomberg) -- Treasuries headed for their best first half in 15 years with two-year yields at a record low as tumbling stocks drove demand for the safest securities. U.S. government debt rallied because of “fear and greed, but mostly fear,” James Caron, global head of interest-rate strategy at Morgan Stanley in New York, wrote to clients. Treasuries returned 5.8 percent in the first six months of 2010, according to Bank of America Merrill Lynch indexes. The MSCI World Index of shares plunged 10.5 percent in the period. “Things are bad in the stock market, and that’s driving yields lower,” said Tsutomu Komiya, who handles U.S. government debt in Tokyo at Daiwa Asset Management Co., which has $77 billion in assets. “The economic data this month was poor. Growth in the U.S. economy will slow.” The two-year yield fell as low as 0.5856 percent today, extending its decline to record levels, according to data compiled by Bloomberg. The note yielded 0.60 percent as of 6:47 a.m. in London. The 0.625 percent security due June 2012 traded at 100 1/32. Ten-year rates were unchanged at 2.95 percent. Two-year yields yesterday broke the prior low of 0.6044 percent, which was set Dec. 17, 2008, after the Federal Reserve cut its target for overnight bank lending to a range of zero to 0.25 percent as it tried to stem the global financial crisis. Treasuries’ first-half rally is the steepest since 1995, when the Fed was preparing to cut interest rates to spur growth. German bunds gained 7 percent this year, U.K. gilts rallied 5.5 percent, and Japanese bonds advanced 2 percent, the Bank of America indexes show. Quarterly Gain For the past three months, Treasuries gained 4.7 percent, the best quarter since the height of the financial crisis at the end of 2008. Treasuries are rising on speculation slowing economic growth will keep inflation in check. The pace of expansion will decline to 2.9 percent in 2011 from 3.2 percent in 2010, Bloomberg surveys of analysts show. Best Buy Co., the world’s largest consumer-electronics retailer, this month reported first-quarter profit that rose less than analysts projected. The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices, fell to 1.90 percentage points from this year’s high of 2.49 percentage points in January. Deflation Morgan Stanley’s Caron said notes can gain further, yet he took issue with the view there is deflation in the U.S. economy. Deflation, a general drop in prices, would bring down 30- year yields relative to 10-year rates, Caron said in his report yesterday. Yet the opposite is happening, he wrote. Thirty-year securities are among the most sensitive to the cost of living because of their long maturity. The difference between 10- and 30-year yields was 98 basis points yesterday, the most in 2010 and almost double the average over the past decade. “It’s too early to conclude that deflation is truly at work,” Caron wrote. “We expect the upward bias in yields will re-assert itself” as the economy expands, he said. “The lower yields move now, the more ferociously they will snap back later.” Morgan Stanley is one of the 18 primary dealers that are required to bid at the government’s debt sales. Ten-year yields will rise to 3.75 percent by year-end, according to a Bloomberg survey of financial companies with the most recent forecasts given the heaviest weightings. European Crisis The U.S. economy is strengthening, though the debt crisis in Europe is a hurdle, President Barack Obama said yesterday after meeting with Fed Chairman Ben S. Bernanke. The euro fell to a four-year low against the dollar this month as Greece and other nations in the region struggled to cut their budgets. Greek bonds will be removed from major sovereign debt benchmarks as June ends after Moody’s Investors Service cut its rating on the securities to less than investment grade this month, Brian Kim, a currency strategist at UBS AG in Stamford, Connecticut, wrote to clients. The shift will lead some money managers to sell Greek securities and reinvest the funds in Germany, France and Italy, according to UBS, the world’s second-largest currency trader. Treasuries rallied yesterday as reports showed U.S. consumer confidence fell more than economists forecast and an index of China’s leading economic indicators had the smallest gain in five months in April. “Bonds are saying this economy is getting bad,” said Michael Franzese, managing director and head of Treasury trading at Wunderlich Securities Inc. in New York. --With assistance from Susanne Walker and Cordell Eddings in New York. Editors: Nicholas Reynolds, Garfield Reynolds To contact the reporters on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net. To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net.

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