Treasuries rallied, pushing the two- year note yield to an all-time low, as U.S. companies added fewer jobs in June than economists forecast and China’s manufacturing growth slowed. The extra yield investors demand to hold 10-year notes over 2-year debt dropped the most in six weeks on heightened deflation concern. The U.S. government will sell $12 billion in 10-year Treasury Inflation Protected Securities on July 8. “Whoever is calling for a double dip is emboldened by this week,” said Suvrat Prakash, an interest-rate strategist in New York at BNP Paribas SA, one of the 18 primary dealers obligated to participate in Treasury auctions. “We have to be a little more cautious about what we expect in the future.” The yield on the 10-year note dropped this week by 13 basis points, or 0.13 percentage point, to 2.98 percent, according to BGCantor Market Data. The price of the 3.5 percent security maturing in May 2020 increased 1 1/8, or $11.25 per $1,000 face amount, to 104 13/32. The benchmark note’s yield fell the most since the five days ended May 21, when it dropped 22 basis points. It touched 2.88 percent on July 1, the lowest level since April 28, 2009. The two-year note yield slid 3 basis points to 0.62 percent after reaching the all-time low of 0.5856 percent on June 30. The difference between 10- and 2-year note debt, known as the yield curve, dropped this week to 2.36 percentage points after touching 2.28 percentage points on July 1, the lowest level since Oct. 2. Flattened Curve The narrowed spread indicates investor preference for longer-term bonds, which tend to rise on slowing inflation. Two- year rates tend to track the outlook for the Fed’s target rate for overnight lending. “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. “People are going across the curve. They are buying for yield and capital preservation.” Private employers added 83,000 jobs in June, the Labor Department reported yesterday. The median forecast of 50 economists in a Bloomberg News survey was for an increase of 110,000 positions. Total U.S. nonfarm payrolls dropped by 125,000 last month as the government cut 225,000 temporary workers conducting the 2010 Census. The unemployment rate decreased to 9.5 percent from 9.7 percent. Fed Rate Outlook Futures on the CME Group Inc. exchange showed a 17 percent chance of the Fed raising its target lending rate for overnight lending between banks by at least a quarter-percentage point by the December meeting, compared with 36 percent odds a month ago. There’s a “small risk of deflation,” and the rebound from the worst recession since the 1930s faces risks from Europe’s sovereign-debt crisis, drops in state and local spending, commercial real estate losses and the Gulf of Mexico oil spill, Atlanta Fed President Dennis Lockhart said this week in a speech in Baton Rouge, Louisiana. “Fed tightening is being moved further and further out into the future,” said William O’Donnell, head U.S. government bond strategist in Stamford, Connecticut, at Royal Bank of Scotland Group Plc, a primary dealer. “There are still headwinds out there. There’s no glimmer of them even considering a tightening.” The difference between yields on 10-year notes and TIPS, a gauge of the inflation outlook known as the break-even rate, narrowed 0.18 percentage point this week to 1.77 percentage point after reaching the 2010 high of 2.49 percentage points on Jan. 11. TIPS Sale Next week’s TIPS sale follows an $8 billion auction on April 5 that drew a yield of 1.709 percent, compared with the average forecast of 1.75 percent in a Bloomberg News survey of primary dealers. Inflation-indexed securities are intended to provide investors with a hedge against inflation. The securities rise or fall in value with movements in the government’s consumer price index, with a three-month lag. The consumer price index dropped 0.2 percent in May in the biggest decrease since December 2008, the Labor Department reported June 17. Treasury 10-year notes will “retest the lows in yields we had in 2008,” David Rosenberg, chief economist at Gluskin Sheff & Associates Inc. in Toronto, said yesterday in a radio interview with Tom Keene on Bloomberg Surveillance. “There’s more room for inflation expectations to come down.” The Chinese government’s Purchasing Managers’ Index declined in June more than expected, falling to 52.1 from 53.9 in the previous month. The median forecast in a Bloomberg News survey of 12 economists was for a drop to 53.2. An HSBC Holdings Plc manufacturing index slid to a 14-month low. Goldman Sachs Group Inc. cut its growth forecast for China this year to 10.1 percent from 11.4 percent as government restrictions on lending and real estate slow expansion in the world’s fastest-growing major economy. To contact the reporters on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Alex Kowalski in New York at akowalski13@bloomberg.net

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