By Cordell Eddings and Anna Rascouet Nov. 20 (Bloomberg) -- Treasury two-year note yields fell to the lowest this year on concern the rally in risk assets has outpaced growth prospects and as Federal Reserve officials signaled interest rates will stay low. Three-month bill rates turned negative yesterday for the first time since last year’s credit freeze as the 62 percent rally in the Standard & Poor’s 500 Index from a 12-year low in March has pushed valuations to about 22 times its companies’ reported earnings, the highest level since 2002. Shorter- maturity Treasuries rose amid speculation financial institutions are buying the safest assets to improve balance-sheet quality as 2009 draws to a close. “The economy is still in a rough patch and no one is expecting any super-positive economic data before year end,” said Christian Cooper, an interest-rate strategist at RBC Capital Markets in New York, one of 18 primary dealers that trade with the central bank. “Investors who have cash are parking it in the front. They want to lock in their returns. They are done.” The two-year Treasury yield fell three basis points to 0.68 percent at 8:39 a.m. in New York, contributing to a 13 basis- point decline this week. The 1 percent security due October 2011 rose 1/32, or 31 cents per $1,000 face amount, to 100 20/32. The yield touched to 0.67 percent, the lowest level since December. The three-month bill yield was 0.005 percent, according to Bloomberg data. The 10-year yield was little changed at 3.34 percent. Negative Returns The global average government bond yield dropped to 2.20 percent yesterday from 2.50 percent in August, according to the Merrill Lynch Global Sovereign Broad Market Plus Index. Bill rates were negative last December for the first time since the government began selling the securities in 1929 as investors sought to preserve their principal following the collapse of Lehman Brothers Holdings Inc. Fed officials are stepping up scrutiny of the biggest U.S. banks to ensure the lenders can withstand a reversal of soaring global-asset prices, according to people with knowledge of the matter. Supervisors are examining whether banks such as JPMorgan Chase & Co., Morgan Stanley and Goldman Sachs Group Inc. have enough capital for the risks they take, how much they know about the strength of their counterparties and whether risk managers have authority to influence bank practices and policies. Renewed Urgency The central bank’s monitoring takes on renewed urgency as Chairman Ben S. Bernanke’s pledge to keep the benchmark interest rate near zero for “an extended period” is helping to fuel a surge in assets. The MSCI AC World stock index is up 71 percent since hitting a recession low on March 9. Gold reached an all- time high of $1,145.50 an ounce Nov. 18. The policy is raising the “systemic risk” of new asset bubbles, Bill Gross, who runs the world’s largest bond fund at Pacific Investment Management Co., said in a note posted on the Newport Beach, California-based company’s Web site yesterday. Finance officials in Asia say a bubble fueled by the Fed’s low rates has already arrived. 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 2.18 percentage points from about zero at the end of last year. The figure is in line with the five-year average. Short Positions Two-year notes, among the most sensitive to Fed interest rates because of their short maturity, returned 1.6 percent this year, according to indexes compiled by Bank of America’s Merrill Lynch unit. Ten-year notes, which are more sensitive to inflation, have fallen 6.4 percent. Ten-year yields were as low as 3.1 percent on Oct. 2, and it will be “difficult” for yields to push below that level now, Citigroup Global Markets Inc. said in a report today. “Investors should look to build short positions at current and lower levels,” Amitabh Arora and Joe Leary wrote for Citigroup, a primary dealer. Shorting is borrowing and selling an asset in anticipation of making a profit by buying it back after its price has fallen. With unemployment at a 26-year high of 10.2 percent, Gross said the central bank is unlikely to raise interest rates until nominal gross domestic product increases 4 percent to 5 percent for another 12 months. Fed Bank of St. Louis President James Bullard said on Nov. 18 that experience indicates policy makers may not start to increase borrowing costs until early 2012. Bullard’s comments followed a Nov. 16 speech by Bernanke in which he indicated that the central bank’s extended period of low borrowing costs may be even longer amid economic “headwinds.” Futures contracts on the Chicago Board of Trade showed a 9.9 percent chance the Fed will increase its target for overnight bank loans to 0.5 percent in March, down from a 32 percent likelihood a month ago. To contact the reporter on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Anna Rascouet in London at arascouet@bloomberg.net

Source