By Anchalee Worrachate and Wes Goodman Dec. 15 (Bloomberg) -- Treasuries were little changed, with 10-year yields near the highest level in almost four months, before reports today on factory output and wholesale prices that may show U.S. economic growth and inflation are picking up. The spread between yields on 10-year notes and Treasury Inflation Protected Securities, or TIPS, a gauge of trader expectations for price growth, widened to as much as 2.25 percentage points, the most this year, based on closing prices. The Federal Open Market Committee, led by Chairman Ben S. Bernanke, starts its two-day meeting today. Investors raised bets that the Fed will increase interest rates in March to 17 percent from 12 percent a month ago, Fed funds futures contracts on the Chicago Board of Trade show. “The U.S. economy will outperform market expectations,” said John Stopford, head of fixed-income securities at Investec Asset Management Ltd. in London. “In each of the past four recessions, the market consensus under-estimated the speed of recovery in the first year. Bond yields are looking mispriced and they should be higher.” The 10-year note yielded 3.55 percent as of 9:38 a.m. in London, according to BGCantor Market Data. The 3.375 percent security due November 2019 rose 1/32, or 31 cents per $1,000 face amount, to 98 18/32. The yield was as high as 3.58 percent on Dec. 11, the most since Aug. 24. Ten-year rates will increase to 3.70 percent by the end of June, according to a Bloomberg News survey of banks and securities companies, with the most recent forecasts given the heaviest weightings. Stopford predicts they will be 4.50 percent by the end of 2010. Factory Output Industrial production climbed 0.5 percent in November, quickening from 0.1 percent in October, based on the median forecast in a Bloomberg survey of economists before the Federal Reserve reports the data today. Figures from the Labor Department will show producer prices gained 0.8 percent last month, after a 0.3 percent increase in October, according to a separate Bloomberg survey. Treasuries have lost investors 2.5 percent this year, while corporate bonds returned 26 percent, according to indexes compiled by Bank of America’s Merrill Lynch unit. Investors sought higher-yielding assets as the U.S. economy snapped its steepest recession since the 1930s. Economic recovery combined with increasing government debt sales will send yields higher around the world in 2010, analysts at Bank of America Merrill Lynch including Michael Cloherty in New York, wrote in a report distributed yesterday. “We expect a moderate increase in global rates,” they said. U.S. 10-year yields will rise to 4.25 percent next year, the Bank of America team wrote. Boosting Sales President Barack Obama has increased U.S. marketable debt to $7.18 trillion, the most ever, as he borrows to sustain growth. The U.K. said on Dec. 9 it will boost gilt sales to a record. Germany said Dec. 13 that it plans to sell an unprecedented amount of debt next year. Treasury 10-year yields will climb to 4.50 percent by the end of next year, economists led by Joseph LaVorgna at Deutsche Bank AG in New York wrote in a research note on Dec. 11. Investors should “scale into” bearish positions starting in the second quarter, the report said. Bank of America and Deutsche Bank are two of the 18 primary dealers, companies required to bid at government debt sales. Treasury bulls say the Fed will keep interest rates at a record low to foster economic growth. The jobless rate of 10 percent is near the 26-year high of 10.2 percent set in October. Bernanke said on Dec. 7 the economy faces “headwinds” and he repeated the central bank’s statement that rates are likely to remain low for an “extended period.” FOMC Meeting The FOMC will announce its latest decision on interest rates tomorrow. Fed funds futures contracts on the Chicago Board of Trade show a 100 percent likelihood the central bank will refrain from raising borrowing costs at the meeting. “I don’t see yields going much higher,” said Geoff Howie, an economist and broker at MF Global Singapore Ltd., part of the world’s largest broker of exchange-traded futures and options contracts. “It’s all unemployment. The Fed can’t go too early” to a higher-rate policy. Ten-year yields will fall to 3.4 percent by the end of March, he said. U.S. two-year notes fell for a fourth day yesterday, the longest stretch since the four trading days ended Oct. 19, as demand for the safety of U.S. debt waned after Abu Dhabi agreed to bail out Dubai World with $10 billion. ‘Being Fixed’ “We’re seeing an unwind of the flight-to-quality bid,” said Paul Horrmann, a broker in Jersey City, New Jersey, at ICAP Plc, the world’s largest inter-dealer broker. “Things are being fixed that were worrisome.” Abu Dhabi’s pledge allowed Dubai World’s Nakheel real- estate unit to avoid default on $4.1 billion of bond payments that matured yesterday. Treasuries rose last month as Dubai said it was starting talks with its lenders to restructure debt accumulated during the emirate’s six-year real estate boom. International buying of U.S. financial assets slowed in October, economists said before the Treasury Department reports the figure today. Net purchases of long-term notes, bonds and stocks declined to $37.1 billion from $40.7 billion in September, another Bloomberg survey showed. To contact the reporters on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net; Wes Goodman in Singapore at wgoodman@bloomberg.net

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