By Daniel Kruger Oct. 2 (Bloomberg) -- Treasuries rallied, pushing yields on 10-year notes to the lowest since May, after a government report showed the U.S. economy lost jobs more jobs than forecast in September, reinforcing expectations for a slow recovery from the worst recession since the Great Depression. Ten-year note yields fell for a second day after the Labor Department said employers eliminated 263,000 jobs last month, compared with a median forecast for a decline of 175,000 positions in a Bloomberg News survey. The unemployment rate rose to 9.8 percent from 9.7 percent in August. “It’s a terrible number with big revisions downward for the previous number,” said Thomas Tucci, head of U.S. government bond trading at primary dealer RBC Capital Markets New York. “Treasuries will continue their rally.” The yield on the 10-year note fell six basis points to 3.12 percent at 8:41 a.m. in New York, according to BGCantor Market Data. The yield dropped to as low as 3.104 percent, the least since May 18. The two-year note yield fell 2 basis points to 0.84 percent. September’s losses bring total jobs lost since the recession began in December 2007 to 7.2 million, the biggest decline since the Great Depression. Ten-Year Yields Treasuries handed investors a return of 2.1 percent in the period from July to September, according to Merrill Lynch & Co. indexes, as signs the recovery may be slow drove speculation the Federal Reserve will keep interest rates near historic lows. That was the strongest three-month performance since the last quarter of 2008. The securities fell 4.5 percent in the first six months of the year, according to Merrill data. For the year Treasuries have slipped 2.4 percent, their worst performance to this point since 1994 when they had lost 3.7 percent. The 10-year yield will close 2009 at 3.58 percent, according to a Bloomberg survey of banks and securities dealers, with the most recent forecasts given the heaviest weightings. Two-year yields will increase to 1.18 percent. The U.S. will next week auction $39 billion of three-year notes, $20 billion in 10-year securities, $12 billion in 30- year bonds and $7 billion of 10-year Treasury Inflation Protected Securities over four consecutive days beginning Oct. 5, the Treasury said yesterday. The department sold $73 billion of the maturities the week of July 6, the last time the four securities were offered in the same week. $6.94 Trillion Treasuries’ third-quarter gain came even as the government sold $554 billion of notes and bonds, the most ever in a quarter. So far this year, U.S. sold $1.517 trillion of notes and bonds, compared with $585 billion at the same point last year. Barclays Plc, one of the 18 primary dealers that trade with the Fed, forecasts total 2009 issuance at $2.1 trillion, with $2.5 trillion projected for 2010. President Barack Obama has pushed the nation’s marketable debt to an unprecedented $6.94 trillion in an effort to spur economic growth, support the financial system and service record deficits. The U.S. budget deficit is projected to increase to $1.6 trillion this year, equivalent to 11.2 percent of the nation’s economy, according to the nonpartisan Congressional Budget Office. The economic crisis, which started with the collapse of the U.S. real estate market in 2007, triggered $1.62 trillion of writedowns and credit losses at financial institutions, sending the global economy into its first recession since World War II. ‘Exceptionally Low’ The U.S. government and the Fed have spent, lent or committed $11.6 trillion in a bid to revive the economy and credit markets. The central bank said on Sept. 23 that it would slow the pace of buying under its $1.45 billion program to buy mortgage securities and maintained its pledge to keep interest rates “exceptionally low” for an extended period. The benchmark rate is a range of zero to 0.25 percent. The Fed’s $300 billion Treasury-purchase program is scheduled to expire this month. Fed officials have started talks with bond dealers to use so-called reverse repurchase agreements to drain some of the cash the central bank has pumped into the economy, according to people with knowledge of the discussions. There’s no sense that policy makers intend to withdraw funds anytime soon, said the people, who decline to be identified. To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net.

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