By Susanne Walker and Anchalee Worrachate Oct. 19 (Bloomberg) -- Treasury two-year note yields rose to the highest level this month before reports this week on housing and the economy forecast by analysts to show the U.S. expansion is under way. The benchmark 10-year note was headed for its first monthly loss since June as evidence of a recovery eroded demand for the relative safety of government debt. The securities fell as stocks climbed on speculation company earnings will keep beating expectations and as commodity prices rose. Futures on the Standard & Poor’s 500 Index increased 0.6 percent. “There seems to be people holding on to the idea that the economy is gaining traction,” said Ian Lyngen senior government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “The market is contemplating the risk of policy action and its risk on the front end of the curve.” The yield on the two-year note rose 2 basis points, or 0.02 percentage point, to 0.98 percent at 9:12 a.m. in New York, according to BGCantor Market Data. The 1 percent security maturing in September 2011 decreased 1/32, or 31 cents per $1,000 face amount, to 100 1/32. The 10-year note’s yield was little changed at 3.41 percent. Treasuries fell last week as reports on manufacturing and industrial production added to evidence of an economic recovery, tempering investors’ quest for higher-returning assets amid subdued inflation. Bond Losses “Treasury 10-year rates are now stuck between solid support at 3.50 percent and good resistance near 3.30 percent,” wrote Bill O’Donnell, U.S. government bond strategist at RBS Securities Inc. in Stamford, Connecticut, in a note to clients today. The firm is one of 18 primary dealers that trade with the Federal Reserve. “Buyers will appear at this support level.” Support is an area where buy orders may be clustered. Waning demand for U.S. securities will push the yield on the 10-year note to 3.80 percent by the middle of next year, according to a Bloomberg survey of banks and securities companies, with the most recent forecasts given the heaviest weightings. U.S. government securities lost investors 2.8 percent in 2009, according to Merrill Lynch’s Treasury Master Index. That compares with returns of 1.4 percent from German bonds and 0.2 percent from Japanese debt. Construction started last month on 610,000 U.S. houses at an annual rate, the most since November, according to the median forecast of economists surveyed by Bloomberg before the Commerce Department reports the figure tomorrow. The index of leading economic indicators, due from the New York-based Conference Board on Oct. 22, rose 0.9 percent, according to a separate Bloomberg survey. Fed Tightening The difference between U.S. 5- and 30-year Treasury yields will narrow as the economy improves and the Fed prepares to increase interest rates, JPMorgan Chase & Co. said in a report on Oct. 16. “As the state of the economy improves after a period of low rates, the intermediate maturity rates are the first ones to price in eventual Fed tightening,” fixed-income strategists led by Srini Ramaswamy in New York wrote. Five-year yields will increase to 2.50 percent by Dec. 31 from today’s 2.38 percent, JPMorgan said. Thirty-year rates will be little changed at 4.25 percent. The difference between the two maturities will narrow to 1.75 percentage points based on the forecasts, from 1.86 percentage points today. The spread averaged 0.86 percentage point during the past five years. Fed Speculation An article in Barron’s on Oct. 17 suggested the Fed should raise rates to 2 percent or risk facilitating another bubble. “It’s time for the Federal Reserve to stop talking about an exit strategy and start implementing one,” the article said. “There is no need for short-term rates to remain near zero now that the economy is recovering.” Fed Chairman Ben S. Bernanke and fellow policy makers cut the target rate for overnight loans between banks to a range of zero to 0.25 percent at the end of 2008. They will keep the target there until the third quarter of 2010, when it will increase to 0.5 percent, according to the median estimate of economists surveyed by Bloomberg News from Oct. 1 to Oct. 8. “The Fed has time on its side before making a drastic move to 2 percent,” wrote George Goncalves, chief fixed- income rates strategist at primary dealer Cantor Fitzgerald LP, in a note to clients. “Moving out slowly will allow them to gauge if markets can stand on its own two feet.” A 15 percent drop in IntercontinentalExchange Inc.’s U.S. Dollar Index from its high this year on March 4 means international investors can buy U.S. debt more cheaply. Dollar Weakness “The same yield is more attractive” to foreigners because of the weaker greenback, said Todd White, who oversees government debt trading in Minneapolis at RiverSource Investments, which manages $90 billion of bonds. The greenback will end the year at $1.50 per euro, compared with $1.4919 today, according to the median estimate of 43 forecasts in a Bloomberg survey. The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, widened to 1.98 percentage points, from almost zero at the end of last year. The average over the past five years is 2.18 percentage points. Fed efforts to cap borrowing costs have helped bring down U.S. 30-year fixed mortgage rates to 5.07 percent from this year’s high of 5.74 percent in June, according to Bankrate.com in North Palm Beach, Florida. Ried, Thunberg & Co.’s index measuring investors’ outlook on Treasuries through June declined to 40 for the seven days ended Oct. 16 from 42 for the previous week. A reading below 50 shows investors expect prices to fall. The economic analysis company, based in Jersey City, New Jersey, surveyed 20 fund managers controlling $1.39 trillion. To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net. Anchalee Worrachate in London at aworrchate@bloomberg.net;

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