By Matthew Brown and Wes Goodman Aug. 17 (Bloomberg) -- Treasuries snapped a two-day advance, pushing 10-year yields up from a 17-month low, before government and central bank reports that economists said will show housing and industrial production improved. Longer-maturity bonds, which are more sensitive to inflation expectations, led the declines on speculation separate figures will show producer prices rose last month, easing concern the U.S. is heading for deflation. The Federal Reserve is scheduled to buy Treasuries due from August 2014 to July 2016 today, reviving its purchases to spur the slowing U.S. economy by keeping borrowing costs down. Asian and European stocks gained, damping demand for fixed income. “There’s been a massive rally in Treasuries and the market’s taking a pause for breath as equities strengthen,” said Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets Ltd. in Edinburgh. “Underlying sentiment remains positive for Treasuries as investors remain extremely nervous about the U.S. economic outlook.” The yield on the benchmark 10-year note rose two basis points to 2.59 percent as of 8:04 a.m. in London, according to BGCantor Market Data. The 2.625 security due August 2020 fell 3/16, or $1.88 per $1,000 face amount, to 100 9/32. The rate slid to 2.56 percent yesterday, the lowest since March 2009. Two-year notes yielded 0.50 percent, after falling to a record 0.48 percent earlier today. Thirty-year yields were one basis point higher at 3.72 percent, after falling to a 16-month low of 3.71 percent yesterday. Stamenkovic forecast that 10-year yields won’t drop below 2.5 percent unless the U.S. economy slides into deflation and the Fed starts buying Treasuries with fresh funds, rather than just reinvest money from maturing mortgage assets. Inflation Outlook MSCI’s Asia Pacific Index of shares rose 0.2 percent, while the Stoxx Europe 600 Index added 0.3 percent. The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices, has narrowed to 1.63 percentage points from this year’s high of 2.49 percentage points in January. The five- year average is 2.12 percentage points. Housing starts rose 2 percent in July from June, according to a Bloomberg News survey before the Commerce Department report today. Industrial production gained 0.5 percent, a separate survey showed before the Federal Reserve releases the data. The Labor Department will say producer prices climbed 0.2 percent last month, another survey showed. The Fed plans to buy about $18 billion of Treasuries and inflation-protected debt by the middle of September, according to its website. ‘Big Risk’ “Buying now is a big risk” in the Treasury market, said Hiroki Shimazu, an economist in Tokyo at Nikko Cordial Securities Inc., a unit of Japan’s third-largest publicly traded bank. “I don’t recommend it. The economy is stable.” Investors who are expecting more from the Fed will be disappointed, Shimazu. This year will be similar to 2003, when the Fed cut its main interest rate by a quarter point, less than the half-point reduction some traders expected, he said. Treasuries returned 2.3 percent in 2003, the poorest performance since 2009, according to Bank of America Merrill Lynch indexes. U.S. government debt has returned 8.2 percent this year, according to the indexes, as investors sought the safety of debt as stocks tumbled. MSCI’s World Index of shares has fallen 3.6 percent in 2010, including reinvested dividends. The Fed will begin its Treasury buying today and make its next purchases Aug. 19. The central bank will probably spend $2 billion or more in each of this week’s operations, according to Wrightson ICAP LLC, an economic advisory company in Jersey City, New Jersey, that specializes in U.S. government finance. Yields to Rise The Fed purchased $300 billion of Treasuries last year “to help improve conditions in private credit markets,” according to a statement on March 18, 2009. Ten-year yields will advance to 3.17 percent by year-end, and two-year rates will climb to 0.85 percent, according to a Bloomberg survey of banks and securities companies with the most recent forecasts were given the heaviest weightings. China cut its holdings of Treasury notes and bonds in June by the most ever, raising speculation government securities have become too expensive for some investors. The nation’s holdings of long-term Treasuries fell for the first time in 15 months, dropping by $21.2 billion to $839.7 billion, a U.S. government report showed yesterday. “This may have been opportunistic,” said James Caron, head of U.S. interest-rate strategy at Morgan Stanley in New York, one of 18 primary dealers that trade with the Fed. “Look at the level of yields. If you’ve held a lot of Treasuries, you’ve done well.” To contact the reporter on this story: Matthew Brown in London at mbrown42@bloomberg.net; Wes Goodman in Singapore at wgoodman@bloomberg.net.

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