By Sandra Hernandez Oct. 10 (Bloomberg) -- Treasuries fell on concern the U.S. government will sell more debt to fund a rescue of the financial system as confidence in financial markets deteriorated worldwide. Ten-year notes posted the biggest weekly drop in four months as speculation mounted that the Treasury will take further action to shore up the financial system, driving borrowing needs higher. Some traders sold government securities to raise cash for margin calls, or payment demands on assets purchased with borrowed money, as U.S. stocks sank. ``The U.S. Treasury will need to sell a lot of bonds over the coming months to finance the burgeoning federal budget deficit,'' said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG's Private Wealth Management unit in New York. ``And why should you buy today when probably you can buy at higher yields tomorrow? I'm not a bond bull anymore.'' The yield on the 10-year note climbed 9 basis points, or 0.09 percentage point, to 3.87 percent at 2:06 p.m. in New York, according to BGCantor Market Data. It was the fourth straight day the yield increased, the longest run since May. The 4 percent security due in August 2018 dropped 23/32, or $7.19 per $1,000 face amount, to 101 2/32. The 10-year note's yield was up 25 basis points since the end of last week. It was the biggest five-day increase since the period ended June 13, after the Federal Reserve intensified indications it would fight inflation by raising interest rates. The Fed held the rate the steady until this week. Two-year note yields rose 9 basis points to 1.61 percent. They were up 4 basis points for the week. $2 Trillion Deficit Pollack said he reduced his U.S. government debt holdings this week. He now holds the same percentage of Treasuries contained in the benchmark index he uses to measure performance. Investors are demanding higher yields on U.S. debt as the biggest government intervention in financial markets since the 1930s spurs speculation U.S. funding needs will surge. In the past five weeks, the government has taken over mortgage-finance firms Fannie Mae and Freddie Mac, rescued insurer American International Group Inc., backed the deposits of money-market funds and authorized a $700 billion bank rescue program. The Treasury also plans to buy stakes in banks within weeks, two officials informed of the matter said yesterday. The 2009 budget deficit could be close to $2 trillion, or 12.5 percent of gross domestic product, more than twice the record of 6 percent set in 1983, David Greenlaw, Morgan Stanley's chief economist, told Bloomberg this week. The deficit accounted for 2.2 percent at the end of the second quarter. Auction Calendar ``Supply is going to dominate the Treasury price action,'' said Paul Horrmann, a strategist in Jersey City, New Jersey, at ICAP Plc, the world's largest inter-dealer broker. ``Rates are going to go higher. They have to.'' The U.S. yesterday auctioned $20 billion in notes in the second round of special sales it announced this week to relieve shortages, plus $30 billion of 97-day bills. It sold $20 billion of notes in the first round on Oct. 8. The government will likely increase its regular sales of two- and five-year notes this month by $2 billion each, to a combined $62 billion, according to Wrightson ICAP, a Jersey City, New Jersey-based research firm. The Treasury on Oct. 6 said it ``will continue to increase auction sizes'' and would announce changes to its auction calendar, including a possible reintroduction of the three-year note, in its Nov. 5 quarterly refunding announcement. The Standard & Poor's 500 Index tumbled 5.1 percent today, capping its worse week ever. Margin Calls Some traders sold Treasuries today to meet margin calls as asset prices fell, said Carl Lantz, an interest-rate strategist in New York at Credit Suisse Securities USA LLC, one of the 17 primary dealers that trade bonds with the U.S. central bank. ``There are few things that are in the green right now,'' Lantz said. ``You're trying to sell anything that has a bid for it.'' Yields on short-term U.S. securities indicate investors are still seeking the relative safety of government debt. Rates on three-month Treasury bills, viewed as a haven in times of turmoil, fell 34 basis points to 0.18 percent, the lowest in three weeks. A year ago, the yield was 4.04 percent. Government and central bank actions have yet to thaw the year-long freeze in money markets as banks hoard cash. The difference between what banks and the Treasury pay to borrow for three months, the so-called TED spread, widened to 4.64 percentage points, the most since Bloomberg began compiling the data in 1984, from 1.18 percentage points a month ago. Inflation Expectations Treasury Inflation Protected Securities, or TIPS, indicate traders' inflation expectations are the lowest in almost a decade amid concern that a seizure in credit markets will tip the economy into recession. TIPS maturing in 10 years yielded 0.94 percentage point less than conventional notes, the least since 1999. The gap between the securities' yields reflects the average inflation rate traders expect over the next 10 years. Prices of goods imported into the U.S. fell in September by the most since April 2003 on lower energy costs, the Labor Department said today in Washington. They dropped 3 percent, more than forecast, after declining a revised 2.6 percent in August. Ten central banks including the Fed cut interest rates in the past two days in a bid to revive bank lending. Futures contracts on the Chicago Board of Trade show traders see a 100 percent chance the Fed will reduce its 1.5 percent target rate for overnight lending between banks by at least a quarter-percentage point at its meeting on Oct. 29. `Special Times' Two-year notes, the most sensitive to monetary policy, gained earlier this week after the U.S. passed a $700 billion rescue package for financial companies and Germany, the U.K., Luxembourg and Iceland rescued banks that fell victim to the worsening credit squeeze. ``These are special times,'' said Stuart Thomson, who helps manage $46 billion in bonds at Resolution Investment Management Ltd. in Glasgow, Scotland. ``The markets are completely broken.'' The Fed will cut rates to 0.5 percent, allowing two- year note yields to fall to 0.75 percent next year, he said. The Securities Industry and Financial Markets Association recommended a 2 p.m. market close today and a full close on Oct. 13 for the U.S. Columbus Day holiday. To contact the reporter on this story: Sandra Hernandez in New York at shernandez4@bloomberg.net

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