By Bo Nielsen and Sandra Hernandez Oct. 2 (Bloomberg) -- Treasuries rose, sending two-year note yields the furthest below 10-year note yields since March, on speculation a $700 billion U.S. bank-rescue package will fail to revive the world's largest economy. Gains were led by two-year notes as traders increased bets the Federal Reserve will lower interest rates a half-percentage point to 1.5 percent on Oct. 29. The Senate yesterday passed the rescue plan with inducements so the House would back it after rejecting an earlier version. ``Whatever happens with the rescue plan, you're still going to have long period of slow growth and low rates in the U.S., and that's not a bad story for bonds,'' said Luca Jellinek, a London-based strategist at Royal Bank of Scotland Group Plc. ``On top of that, everyone is understandably cautious before the House vote, given the plan has already been thrown out once.'' The yield on two-year notes fell 7 basis points, or 0.07 percentage point, to 1.74 percent as of 7:56 a.m. in New York, according to BGCantor Market Data. The 2 percent security maturing in September 2010 increased 4/32, or $1.25 per $1,000 face amount, to 100 15/32. Ten-year yields declined 4 basis points to 3.70 percent. The difference between two- and 10-year yields widened to as much as 1.97 percentage points, indicating investors are betting on a greater chance of recession. Treasuries pared gains after Europe's Dow Jones Stoxx 600 Index added 1.4 percent on anticipation the rescue package will be approved in the House this week. Futures on the Chicago Board of Trade show a 60 percent chance the Fed will reduce its 2 percent target rate for overnight bank loans by a half-percentage point at the Oct. 29 meeting. The odds were 34 percent yesterday. Debt Rally Two-year notes, the most sensitive to expectations about the Fed's benchmark rate, gained more than 10-year notes. The difference between the securities' yields grew to the biggest since March 17, after the Fed brokered the sale of Bear Stearns Cos. to JPMorgan as deteriorating credit markets pushed the firm toward bankruptcy. Lehman Brothers Holdings Inc. filed for bankruptcy last month as credit markets seized up further. ``The rally will continue into next year,'' said Hiromasa Nakamura, senior fund investor in Tokyo at Mizuho Asset Management Co., which oversees the equivalent of $37.8 billion as part of Japan's second-largest bank. ``The U.S. economy is in recession. I don't think this legislation will solve that.'' Two-year yields will drop to 1.5 percent by year-end, Nakamura said. `Going to Get Worse' Senators included an increase in bank-deposit-insurance limits and tax breaks for individuals and companies to help revive the rescue plan. The bailout, backed by the administration of President George W. Bush, authorizes the government to buy troubled assets from financial institutions reeling from a record number of home foreclosures. The plan hasn't been enough to allay concern that the U.S. is headed for a recession. ``The recession is going to get worse,'' billionaire Warren Buffett said yesterday in a television interview with Charlie Rose in San Diego for broadcast on the Public Broadcasting Service in the U.S. The U.S. lost 105,000 jobs in September, the most since 2003, according to the median forecast in a Bloomberg News survey of economists before the Labor Department reports the figure tomorrow. Manufacturing in the U.S. contracted in September at the fastest pace since 2001, the Institute for Supply Management reported yesterday. Money Markets U.S. yields indicate inflation expectations approached the lowest in almost six years. The difference between rates on 10- year Treasury Inflation Protected Securities, or TIPS, and conventional bonds narrowed to 1.49 percentage points, near the least since October 2002. The spread reflects the outlook among traders for inflation over the next decade. ``Treasury rates should fall,'' said Satoshi Okumoto, a general manager in Tokyo at Fukoku Mutual Life Insurance Co., with $53.9 billion in assets. ``The weak economic situation will prevail.'' Officials are trying to loosen a seizure in the credit markets after banks became less willing to lend to their peers on concern losses related to U.S. subprime mortgages would worsen. The European Central Bank kept interest rates at a seven- year high today to curb inflation, even after the credit crunch forced governments to bail out banks and increased the likelihood of a recession. The yield advantage of a two-year German government note over equivalent-maturity U.S. securities increased 2 basis points to 1.65 percent. The difference between what banks and the Treasury pay to borrow for three months, the so-called TED spread, was 3.50 percentage points, more than tripling in a month. The figure was 3.54 percentage points on Sept. 29, the most since Bloomberg began compiling the data in 1984. To contact the reporters on this story: Sandra Hernandez in New York at shernandez4@bloomberg.net; Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net

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