Treasuries Rise as Traders Add to Bets for December Rate Cut

By Wes Goodman

Oct. 31 (Bloomberg) -- Treasuries rose, with 10-year notes snapping a four-day slide, on speculation the Federal Reserve will cut interest rates in December for a seventh time this year to revive the shrinking U.S. economy.

Notes climbed before a U.S. government report that economists estimate will show consumer spending fell in September for the first time in two years. The securities returned 4.6 percent so far in 2008, extending a 9 percent rally last year, according to a Merrill Lynch & Co. index, as the global credit crunch sent investors to the safest assets.

``I'm still bullish,'' said Hiromasa Nakamura, senior fund investor in Tokyo at Mizuho Asset Management Co., who correctly predicted a rally in Treasuries this year and in 2007. ``The Fed may cut further because the U.S. economy is slowing down sharply, especially consumer spending.''

The yield on the 10-year note fell 5 basis points to 3.91 percent as of 8:12 a.m. in London, according to BGCantor Market Data. The 4 percent security maturing August 2018 rose 14/32, or $4.38 per $1,000 face amount, to 100 24/32. A basis point is 0.01 percentage point.

Ten-year yields will drop to 3.4 percent by year-end, according to Mizuho Asset Management, which oversees the equivalent of $40.7 billion as part of Japan's second-largest bank. Fed policy makers reduced the rate by half a percentage point to 1 percent on Oct. 29. Two-year yields fell 4 basis points to 1.52 percent.

U.S. government securities returned 0.04 percent this month as of yesterday, according to Merrill Lynch's U.S. Treasury Master index. German government bonds handed investors 2.7 percent in October, and Japanese debt earned 0.4 percent.

Consumer Spending

Consumer spending slipped 0.2 percent in September, according to the median estimate in a Bloomberg News survey of economists before the Commerce Department issues the figure at 8:30 a.m. in Washington.

A Reuters/University of Michigan report at 10 a.m. will show the index of consumer sentiment fell to 57.5 from 70.3 in September, another survey showed.

The number of borrowers at risk of credit-rating downgrades rose to 786 in October, the highest since September 2005, as the credit crisis crimped lending, Standard & Poor's said in a report yesterday.

The cost of protecting Asia-Pacific bonds from default increased by a record in October, helping spur demand for the safety offered by Treasuries.

Default Swaps

The Markit iTraxx Australia index of credit-default swaps climbed 54 basis points this month to 2.54 percentage points, according to CMA Datavision. Credit-default swaps, contracts to protect against or speculate on default, pay the buyer face value if a company fails to adhere to its debt agreements.

Company bonds handed investors a loss of 9.2 percent this month, according to Merrill's U.S. Corporate & High Yield Master index, the most since the firm began compiling the figure in 1997.

Futures on the Chicago Board of Trade show a 55 percent chance the Fed will reduce its target rate to 0.5 percent at its next meeting on Dec. 16, as of late yesterday in New York. The odds increased from 32 percent the day before. The rest of the bets are for a quarter-point reduction.

Treasuries trimmed gains from earlier in the month because of concern U.S. efforts to thaw credit markets and prop up the financial system will swell sales of long-term government debt.

U.S. borrowing needs will almost double this fiscal year to $2 trillion, Goldman Sachs Group Inc. forecast. The U.S. reported gross domestic product shrank 0.3 percent in the third quarter.

`Huge Supply'

``A huge amount of supply is coming,'' said Kei Katayama, who oversees $1.6 billion of non-yen debt as leader of the foreign fixed-income group in Tokyo at Daiwa SB Investments Ltd., part of Japan's second-biggest investment bank. ``No one wants to go to the longer end of the market.''

The difference in yield, or spread, between two- and 10- year securities increased to 2.39 percentage points, near the widest since 2004, from 2.17 points a week ago. The so-called yield curve has steepened as longer-term securities lagged behind in anticipation of increased government debt auctions.

Yields indicate banks are more willing to lend. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, narrowed to 2.82 percentage points, from 3.15 percentage points at the end of September.

Kokusai On Yields

Demand for the safest investments will favor the dollar, said Masataka Horii, one of four investors for the $47.9 billion Kokusai Global Sovereign Open fund in Tokyo, the biggest bond fund in Asia.

``That will continue until around the middle of November,'' Horii said. ``We're not that concerned about supply. The most important thing is yield. U.S. yields are still attractive versus Japanese yields.''

Ten-year Treasuries yield 2.42 percentage points more than similar-maturity debt in Japan, widening from 1.86 percentage points in the middle of September.

Japanese bonds rose after the Bank of Japan lowered its benchmark interest rate to 0.30 percent from 0.50 percent. A Bloomberg survey showed 15 of 17 economists expected a quarter- point cut to 0.25 percent.

The yield on the 1.5 percent bond maturing in September 2018 dropped 1 basis point to 1.48 percent.

Global Sovereign Open increased its holdings of dollar- denominated bonds to 28 percent of assets from 27 percent in October, Horii said. It raised yen holdings to 15 percent from 9.5 percent. The fund trimmed euro bonds to 37 percent from 39 percent, he said.

To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.