By Theresa Barraclough Feb. 18 (Bloomberg) -- Treasury 10-year yields were near the highest level in five weeks before a government report that economists said will show producer-price inflation accelerated last month, damping the allure of government debt. U.S. notes fell yesterday after minutes of the Federal Reserve’s January meeting showed policy makers boosted forecasts for economic growth and inflation and discussed starting sales of assets in the “near future.” The U.S. will today announce $128 billion in debt sales next week, according to Wrightson ICAP LLC, an economic advisory firm in Jersey City, New Jersey. “We’ll start to see gradual upward pressure on Treasury yields,” said Kei Katayama, who oversees $1.6 billion of non- yen debt at Daiwa SB Investments Ltd., a unit of Japan’s second- biggest investment-banking group. “The Fed has to start exit policy by fixing its balance sheets before changing monetary policy. Although, should inflation pick up, the Fed may hurry rate hikes.” The 10-year note yielded 3.73 percent as of 6:48 a.m. in London, according to BGCantor Market Data. The 3.625 percent note due February 2020 rose 1/32, or 31 cents per $1,000 face amount, to 99 1/8. The yield climbed to 3.76 percent yesterday, matching the highest since Jan. 14. Officials unanimously agreed the central bank’s $2.26 trillion balance sheet will need to shrink “substantially over time” and return its holdings to just Treasuries, according to minutes of the Fed’s Jan. 26-27 meeting released yesterday. Asset Sales Several officials pushed to begin asset sales “to ensure that the Federal Reserve’s balance sheet shrinks more quickly and in a more predictable manner than could be achieved solely by redeeming maturing securities,” the minutes showed. The U.S. economy will grow between 2.8 percent and 3.5 percent this year, the Fed said, compared with 2.5 percent to 3.5 percent in its November forecast. Prices, excluding food and energy costs, will rise by 1.1 percent to 1.7 percent this year, compared with an earlier estimate of 1 percent to 1.5 percent. Producer prices climbed 0.8 percent in January, after increasing 0.4 percent the previous month, according to economists surveyed by Bloomberg News before today’s Labor Department report. The spread between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices, was 2.29 percentage points, compared with 1.15 percentage points a year ago. Spread Widens Declines in longer-term debt expanded the spread between two-and 10-year yields to as much as 2.90 percentage points yesterday, tying the record set on Jan. 11. The gap, also known as the yield curve, was 2.89 percentage points today. “The curve is adjusting itself to new central tendencies on GDP and the Fed’s very gentle increase in its outlook for inflation,” Christopher Sullivan, who oversees $1.6 billion as chief investment officer at United Nations Federal Credit Union in New York, said yesterday. “The direction of rates should be slightly higher from here.” The U.S. will next week sell $10 billion of 30-year TIPs, $44 billion in two-year notes, $42 billion in five-year debt and $32 billion of seven-year notes, according to Wrightson ICAP. The TIPS auction is scheduled for Feb. 22, followed on succeeding days by the two-, five- and seven-year sales. Jobless Rate Treasury bulls say bonds are set to rise on speculation a weak labor market will drag on the economic recovery, encouraging investors to seek safer assets. The unemployment rate will average 9.5 percent to 9.7 percent in the fourth quarter, the Fed said yesterday, compared with the forecast for 9.3 percent to 9.7 percent made in November. The jobless rate declined to 9.7 percent last month. “I’m bullish for Treasuries because the economic recovery will not continue,” said Yasutoshi Nagai, chief economist in Tokyo at Daiwa Securities Capital Markets Co., part of Japan’s second-largest brokerage. “After the effects of the stimulus packages runs out, there’ll be an unwinding of the recovery momentum. The employment situation is bad, which will push Treasury yields down.” Initial jobless claims fell to 438,000 last week, from 440,000 the previous week, according to a Bloomberg survey before today’s Labor Department report. Claims have averaged 357,000 during the past decade. Ten-year yields are likely to decline to 3.5 percent by the end of March, Daiwa’s Nagai said. Should his predictions prove accurate, investors who buy the debt today would make a return of 2.3 percent, Bloomberg calculations show. To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net.

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