U.S. 10-Year Notes Fall on Concern About Supply, Bank Program

By Daniel Kruger

Oct. 18 (Bloomberg) -- Ten-year Treasury notes dropped for a second week as investors focused on the prospect of greater U.S. borrowing and the impact of the Bush administration's plan for the U.S. to invest in banks.

Yields on the notes rose as the government said it posted a record $455 billion budget deficit for the year ended Sept. 30. Morgan Stanley has predicted the shortfall may almost quadruple as the Treasury uses $700 billion to rescue the financial system from the credit crisis. Stocks gained for the week, with the Standard & Poor's 500 Index rising the most in eight months.

``People are still trying to get a handle on the supply, when it's going to come,'' said James Collins, an interest-rate strategist at Citigroup Global Markets Inc. in Chicago, one of the 17 primary dealers that trade with the Federal Reserve. ``It's obvious it's going to be enormous.''

The yield on the 10-year note rose 6 basis points for the week, or 0.06 percentage point, to 3.93 percent, according to BGCantor Market Data. It touched a 2 1/2-month high of 4.10 percent on Oct. 15. The 4 percent security maturing in August 2018 fell 15/32, or $4.69 per $1,000 face amount, to 100 17/32.

Two-year note yields declined 3 basis points to 1.62 percent.

Treasury 10-year notes underperformed two-year notes amid speculation the government will conduct a second set of special auctions to relieve shortages in the market for borrowing and lending Treasuries. The U.S. on Oct. 8 and 9 sold $40 billion in debt over two days in special sales it announced on Oct. 8.

Awaiting an Announcement

``On a daily basis, people have been looking for the Treasury to come in and make another announcement,'' said Tom Tucci, head of U.S. government bond trading in New York at RBC Capital Markets, the investment-banking arm of Canada's biggest lender. Treasuries with five-, seven- and 10-year maturities ``had been hit really hard'' as traders anticipated new auctions.

The government last week also said it would continue increasing sizes of regular debt sales and consider selling new maturities, and would make any changes to its auction calendar at its Nov. 5 refunding announcement.

``I don't think you buy Treasuries,'' said Bill Gross, who is co-chief investment officer of Pacific Investment Management Co. and runs the $129.6 billion Total Return Fund. He spoke in an interview on Bloomberg Radio from Newport Beach, California, where Pimco is based. ``They're obvious flight-to-quality vehicles.''

Confidence to Revive

The efforts of governments and central banks worldwide may restore investor confidence in ``weeks,'' Gross said. The U.S. and other nations have agreed to spend almost $3 trillion to rescue banks imperiled by the credit crisis. The Treasury on Oct. 14 said it plans to buy $250 billion of shares in U.S. banks and offer guarantees on new debt.

Rates on three-month Treasury bills, viewed as a haven because of their short maturities, rose 61 basis points for the week to 0.79 percent, the highest level since Oct. 7.

The S&P 500 Index climbed 4.6 percent, the most since February, capping a volatile week for equities. Investor Warren Buffett said he's buying stocks. Writing in the New York Times, he said ``a simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread.''

Traders added to bets the Fed will cut borrowing costs for a second time this month at its Oct. 29 meeting to bolster the economy. Futures on the Chicago Board of Trade yesterday showed traders saw a 38 percent chance the Fed will cut its target rate for overnight bank loans by a half-percentage point to 1 percent at its Oct. 29 meeting. The odds were 28 percent a week earlier. The rest of the bets were for a quarter-point reduction.

Signs of Thawing

Reports showed the economy slowing. Construction of single- family homes plunged to the lowest level in 26 years, the Commerce Department said yesterday. Industrial production fell last month by the most in almost 34 years, the Fed said Oct. 16, and retail sales declined in September for a third month, the longest in at least 16 years, Commerce said Oct. 15.

Even so, money markets exhibited signs of thawing. The London interbank offered rate, or Libor, for borrowing in dollars overnight fell for a sixth day yesterday, slipping 27 basis points, to 1.67 percent. That's the lowest level since September 2004.

The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, fell 1 percentage point last week to 3.63 percentage points. It was 4.64 percentage points on Oct. 10.

To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net