The extra yield investors demand to hold Treasury 10-year notes over 2-year debt fell to the lowest level since October as an increase in initial jobless claims and slower manufacturing growth raised the risk of deflation. The 10-year note yield stayed below 3 percent for a third day after breaching that level this week for the first time in more than a year. China’s manufacturing growth slowed in June, while the Labor Department’s payrolls report tomorrow is forecast by economists to show the U.S. lost jobs. “The outlook for growth has become quite bleak, which is giving confidence to Treasury investors to extend along the curve, adding longer-dated instruments,” said Christopher Sullivan, who oversees $1.6 billion as chief investment officer at the United Nations Federal Credit Union in New York. The difference between 10- and 2-year note debt, known as the yield curve, dropped for a fourth day to 2.30 percentage points at 10:23 a.m. in New York, after earlier reaching 2.29 percentage points, the smallest on an intraday basis since Oct. 8, when it was 2.28 percentage points. The narrowing spread indicates investor preference for longer-term bonds, which tend to rise on slowing inflation. Two- year rates tend to track interest rates. Yields on 10-year notes fell three basis points to 2.90 percent, according to BGCantor Market Data. The price of the 3.5 percent security maturing in May 2020 increased 9/32, or $2.81 per $1,000 face amount, to 105 1/8. Two-Year Note The two-year yield was little changed at 0.61 percent, after touching a record low of 0.5856 percent yesterday. The 30- year bond yield dropped four basis points to 3.85 percent. U.S. employers cut 125,000 jobs last month, according to the median forecast of 71 economists in a Bloomberg News survey. A lower-than-expected 431,000 new jobs in May included a 411,000 jump in government hiring of temporary workers for the 2010 census, the Labor Department said on June 4. The report for June is due tomorrow at 8:30 a.m. New York time. Initial jobless claims climbed to 472,000 in the week ended June 26 from a revised 459,000 in the previous week, the Labor Department reported today. The median forecast of 46 economists in a Bloomberg News survey was for a decrease to 455,000 from a previously reported 457,000. “We’ve had several reports indicating global growth is slowing, and we’re seeing signs that the U.S. labor market isn’t improving at the pace that we’d like to see,” said Elwin de Groot, a senior market economist at Rabobank Groep in Utrecht, Netherlands. “If you take all this together, the picture for Treasuries looks positive.” Manufacturing Slowdown The Institute for Supply Management’s gauge of manufacturing fell to 56.2 in June from 59.7 a month earlier, according to the Tempe, Arizona-based group. A reading greater than 50 points to expansion. The index of pending home resales dropped 30 percent in May from the prior month, figures from the National Association of Realtors showed today in Washington. The drop was the biggest in records dating to 2001 and compared with a 14 percent decrease forecast in a Bloomberg News survey of economists. The Chinese government’s Purchasing Managers’ Index declined for a second month in June, falling to 52.1 from 53.9 in the previous month. The median forecast in a Bloomberg News survey of 12 economists was 53.2. An HSBC Holdings Plc manufacturing index slid to a 14-month low. The Federal Reserve can keep its target rate for overnight lending at the current range of zero to 0.25 percent without worrying it will lead to inflation, Goldman Sachs Group Inc. economists including Jan Hatzius in New York wrote in a report yesterday. Bubble Risk ‘Low’ “The ‘bubble risk’ associated with an easy monetary policy is currently low,” according to Goldman, one of the 18 primary dealers that trade directly with the central bank. Traders have reduced bets that inflation will accelerate, the so-called break-even rate indicates. The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of expectation for consumer-price gains, has narrowed 12 basis points this week to 1.82 percentage points. It was 2.49 percentage points on Jan. 11. The consumer price index dropped 0.2 percent in May in the biggest decrease since December 2008, the Labor Department reported June 17. Two-year notes fell today as some investors bet that yields may have dropped to levels not justified by the outlook for the world’s largest economy. “Given where valuations are, there’s certainly more risk of a setback” in bond prices, said Christoph Rieger, co-head of fixed-income strategy at Commerzbank AG in Frankfurt. “The Treasury market may be hoping for too much of more negative readings that may not materialize.” To contact the reporter on this story: Cordell Eddings in New York at ceddings@bloomberg.net

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