Treasury 10-year notes headed for a fourth weekly gain, the longest run since February, as the government announced a reduction in debt sales while the Federal Reserve began buying. The U.S. said it plans to auction $102 billion of two-, five- and seven-year notes next week, the smallest monthly offering of that combination of securities since May 2009. The Fed bought $6.16 billion of notes this week, part of its plan to spur the slowing U.S. economy by keeping borrowing costs low. “Long-end maturities look attractive,” said Masataka Horii, one of the investors for the $38.8 billion Kokusai Global Sovereign Open Fund in Tokyo, Asia’s largest bond fund. “The U.S. is trying to cut the size of its budget deficit, which will lead to less supply.” The 10-year note yielded 2.56 percent as of 5:53 a.m. in London, according to data compiled by Bloomberg. The 2.625 percent security due in August 2020 traded at 100 18/32. The rate declined about 44 basis points in four weeks. Rates on two-year notes were 0.48 percent, after falling to a record low of 0.4715 percent yesterday. The MSCI Asia Pacific Index of shares dropped 1.5 percent, snapping a five-day rally and helping increase demand for the relative safety of government debt. Treasuries have returned 8.2 percent in 2010, according to Bank of America Merrill Lynch indexes, as investors sought safety as stocks fell. MSCI’s World Index of shares handed investors a 4 percent loss, accounting for reinvested dividends. Kokusai Extends Duration The difference between two- and 10-year yields narrowed to 2.08 percentage points, and it was as low as 2.06 percentage points this week, the least in almost 16 months. Two-year rates tend to track the Fed’s target for overnight lending because of their shorter tenor. Longer-term yields are more influenced by the size of the government debt and inflation. Kokusai Global Sovereign Open increased the duration of its U.S. debt holdings to 5.7 years now from 5.2 years at the start of 2010, Horii said. The benchmark the fund uses to gauge performance, the Citigroup World Government Bond Index, has a duration of 5.2 years, he said. Duration is a measure of a portfolio’s sensitivity to yield changes, and a larger figure indicates a more bullish position. The government, in its auction announcement yesterday, also cut a sale of 30-year Treasury Inflation Protected Securities scheduled for next week to $7 billion from $8 billion. Fed Purchases An expansion in the economy this year after a contraction in 2009 is raising speculation among some investors that tax revenue will increase and allow the government to reduce the amounts by which it overspends. The U.S. Congressional Budget Office said yesterday the budget deficit for the year that starts Oct. 1 will be $1.066 trillion, revised up from an estimate of $996 billion in March. The Fed bought $6.16 billion of Treasuries this week. It plans to buy notes due from 2013 to 2014 on Aug. 24 and debt maturing from 2021 to 2040 on Aug. 26, according to its website. The central bank will snap up about $18 billion of U.S. debt by the middle of September using the money from principal payments on its holdings of agency debt and agency mortgage- backed securities, according to the website. St. Louis Fed President James Bullard said yesterday the Fed should buy more Treasuries if the weakening economy shows slowing inflation. He will speak today in Rogers, Arkansas. Inflation Outlook The difference between yields on 10-year notes and TIPS, a gauge of trader expectations for consumer prices, narrowed to 1.57 percentage points. It was the least since July 2009. Yields are poised to rise given the pace of growth in the U.S. economy, said Peter Jolly, the Sydney-based head of market research for the investment-banking unit of National Australia Bank Ltd., the nation’s largest lender. Two-year notes yielded 23 basis points more than the upper range of the Federal Reserve’s target for its benchmark interest rate, the least since the central bank cut borrowing costs to near zero in December 2008. “Yields are too low,” he said. “To buy Treasuries here, you’d have to believe that the economy is heading for a double dip recession and the Fed won’t respond to it.” Bloomberg surveys of banks and securities project the U.S. economy will grow 3 percent in 2010 after shrinking 2.6 percent last year, even though the expansion is slower than first expected. The 10-year yield will rise to 3.16 percent by Dec. 31, the surveys show. Jolly predicts 3 percent by year-end. Treasuries gained yesterday after the Fed Bank of Philadelphia’s economic index fell and unemployment claims rose. “The weaker-than-expected figures from the Philadelphia Fed and the jobless claims combined have brought up fears of a double dip,” said Ira Jersey, an interest-rate strategist at Credit Suisse Group AG, one of 18 primary dealers that trade directly with the Fed. “Twos are going to 40 to 44 basis points by year-end.” To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.

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