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BLBG: Treasuries Fall on Speculation U.K. Preparing to Bail Out Banks
By Bo Nielsen

Oct. 7 (Bloomberg) -- U.S. Treasuries fell on speculation the U.K. government may invest at least 45 billion pounds ($79 billion) in banks to bolster capital depleted by mortgage- related losses.

The decline pushed the yield on two-year notes up from the lowest level since March and helped European equities rise after two people with knowledge of the situation said the U.K. may invest in banks including Royal Bank of Scotland Group Plc, which had its debt rating cut by Standard & Poor's yesterday. Iceland's government today took over Landsbanki Islands hf, the island nation's No. 2 lender, in an attempt to avoid a default and pegged the krona to a trade-weighted index.

``We've had a big rally over the last couple of weeks in Treasuries so people are taking some of that money off the table,'' said Wilson Chin, a fixed-income strategist in Amsterdam at ING. ``But it's still too early to call the end of the flight to safety.''

The yield on the 10-year note rose 5 basis points to 3.50 percent as of 6:37 a.m. in New York, according to BGCantor Market Data. The 4 percent security maturing in August 2018 dropped 13/32, or $4.06 per $1,000 face amount, to 104 4/32. Two-year yields climbed 5 basis points to 1.48 percent.

U.S. notes also fell as European stocks erased declines and stock-index futures reversed losses after Deutsche Bank AG, Germany's biggest lender, said it isn't planning to raise capital. Europe's Dow Jones Stoxx 600 Index added 0.8 percent after plunging 7.6 percent yesterday.

Australian Rates

Demand for the safest assets ebbed after Australia's central bank cut interest rates by the most since 1992, spurring speculation more banks may follow suit to head off a global recession.

The drop in U.S. government debt snapped the longest rally in a month as investors sought a haven amid weakness in credit markets and European bank rescues.

``Treasuries are under a bit more pressure because of the renewed risk appetite,'' said Orlando Green, a fixed-income strategist in London at Calyon, a unit of Credit Agricole SA. ``But it's a fragile move.''

News of plans to shore up British banks followed the agreement yesterday by Germany and financial institutions on a rescue package for Hypo Real Estate Holding AG and BNP Paribas SA's decision to join a state-backed bailout of Fortis, Belgium's largest financial-services company.

``There's a lot of focus on the credit crisis in Europe at the moment,'' said Mik Ingenuus Joergensen, head of research in Copenhagen at Nordea Markets, part of the biggest Scandinavian Bank.

U.K. Rescues

The U.K. government has already bailed out Bradford & Bingley Plc and brokered the takeover of HBOS Plc in the past month on concern about the banks' ability to fund themselves. Chancellor of the Exchequer Alistair Darling said yesterday he will do ``whatever it takes'' to keep the financial system stable as capital markets remain frozen.

Iceland's Financial Supervisory Authority took control of Landsbanki because there is ``a risk of default,'' Chamber of Commerce spokesman Finnur Oddson said in an interview today.

Banks have been hoarding cash on concern that credit- related losses are spreading. The TED spread, or the difference between what banks and the U.S. Treasury pay to borrow money for three months, dropped to 3.74 percentage points today, after earlier widening to 3.91 percentage points, from 3.82 percentage points yesterday.

The cost of borrowing in dollars overnight jumped more than a percentage point, the British Bankers' Association said today. The London interbank offered rate, or Libor, that banks charge each other for such loans climbed 157 basis points to 3.94 percent, BBA data showed today.

To contact the reporter on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net