Oct. 10 (Bloomberg) -- Treasury 30-year bonds plunged the most in two months after demand was lower than average at a $12 billion auction of the securities and Ben S. Bernanke said the Federal Reserve is ready to tighten monetary policy. The difference in yields between two- and 30-year government debt increased to the widest amount in three weeks as yields on the longest maturity Treasuries climbed from near the lowest levels since April. The Fed releases minutes of its Sept. 23 meeting next week, while other reports are forecast by economists to show retail sales declined in September while the cost of living increased 0.1 percent from the prior month. “There was something about the 30-year auction where people said, ‘enough of this already,’” said Jason Brady, a managing director at Thornburg Investment Management in Santa Fe, New Mexico, which oversees $4 billion in fixed-income. “What’s notable to me is the curve continues to steepen. To a certain degree, there’s an inflation component in that.” The yield on the 30-year bond rose 23 basis points, or 0.23 percentage point, to 4.22 percent this week, according to BGCantor Market Data. That’s the most since it shed 31 basis points over the five days ended Aug. 7. The 4.5 percent security maturing August 2039 fell 4 3/32, or $40.94 per $1,000 face amount, to 104 20/32. The 30-year bond yield had declined three-quarters of a percentage point since Aug. 11, falling below 4 percent on Oct. 1 for the first time since April, amid signs recovery from the worst slump since the Great Depression would be slow. The 10-year note yield rose 16 basis points to 3.38 percent while the two-year note’s yield gained 10 basis points to 0.96 percent, the biggest rise in two months for both. ‘Levels Are Overpriced’ The bid-to-cover ratio at the on the Oct. 8 30-year sale, which gauges demand by comparing total bids with the amount of securities offered, was 2.37, compared with 2.92 at the September auction and an average of 2.42 for the past 10 sales. “The auction was very tepid,” said Tom di Galoma, head of fixed-income rates trading at Guggenheim Capital Markets LLC, a New-York based brokerage for institutional investors. “The auction shows that the market can sell off when levels are overpriced.” The Treasury sold $78 billion in notes and bonds during the week. The government has auctioned $1.6 trillion of coupon securities so far this year, compared with $892 billion for all of 2008, as President Barack Obama attempts to stimulate the economy and service record deficits. ‘Down The Road’ “As economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road,” Bernanke said yesterday at a Board of Governors conference on monetary economics in Washington. “When the economic outlook has improved sufficiently, we will be prepared to tighten.” The Fed will hold off raising interest rates until the third quarter of 2010 as the recovery is likely to be too weak to lift employment and incomes, according to a September survey of 57 economists by Bloomberg News. Futures on the Chicago Board of Trade show a 40.5 percent chance the central bank will boost borrowing costs from the current range of zero to 0.25 percent by March. Bernanke’s comments were “a reiteration of what they’ve been saying all along, that they will raise rates when the economy is back on its feet,” said Christian Cooper, an interest-rate strategist at primary dealer RBC Capital Markets in New York. “The story going forward will be an abandonment of the front end as the search for yield continues.” Draining Cash The 10-year yield could fall as low as 3.1 percent “as stalling economic improvements have outweighed auction supply,” analysts led by New York-based Brett Rose at Citigroup Inc. wrote in a note to clients published yesterday. The high end of their range is 3.7 percent, according to the note. The 10-year note yield touched 3.1 percent, the lowest level since May, on Oct. 2, before rebounding to 3.38 percent. The Fed is considering accessing money market funds through clearing banks or creating a facility to drain the record amount of cash added to the financial system, according to people familiar with the plans. Those methods may help conserve the capital of the 18 primary dealers that act as counterparties for open market transactions as the Fed removes some of the more than $1 trillion the central bank pumped the economy, said the people, who declined to be identified because no decision has been made. Notion Rejected White House economic adviser Lawrence Summers rejected the notion that the U.S. faces an extended period of below-average growth and high unemployment in the wake of the worst recession since the 1930s. “I would be very reluctant to accept the idea that the American economy no longer has the potential to grow rapidly,” Summers told a forum in New York Oct. 8 organized by Bloomberg LP, the parent of Bloomberg News. “The American people have not become less capable of entrepreneurship. They have not become less dedicated to hard work, and the productive potential of this economy has not declined.” The gap in yields between 10-year Treasury Inflation Protected Securities and conventional notes widened 0.15 percentage point, the most in six weeks, to 1.85 percentage points. The Labor Department is likely to say Oct. 15 that consumer prices fell 1.4 percent in September from their level a year ago after falling 1.5 percent in August, according to a Bloomberg News survey of 29 economists. A separate survey of 57 economists suggests the department will say prices rose 0.2 percent from the previous month after rising 0.4 percent in August. Consumer prices will rise to 2.3 percent by the end of 2011, according to the median estimate of 45 forecasters in a Bloomberg New survey that puts a greater weighing on the most recent projections. Sales at U.S. retailers declined 2.1 percent in September, according to the median estimate of 40 economists surveyed by Bloomberg News before the report on Oct. 14. To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net; Cordell Eddings in New York at ceddings@bloomberg.net.

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