By Cordell Eddings and Lukanyo Mnyanda March 9 (Bloomberg) -- Treasuries advanced as a drop in U.S. stocks encouraged demand for the relative safety of government debt before a record-tying $40 billion auction of three-year notes. Government debt also rose as Brian Sack, the New York Federal Reserve Bank’s markets chief, said yesterday a “gradual and passive” reduction in the central bank’s $2.3 trillion balance sheet outlined last month by Chairman Ben S. Bernanke would limit a reversal of the low borrowing costs fostered by $1.69 trillion of securities purchases. “To know that asset sales are not yet in the cards has brought some relief to the Treasury market,” said David Ader, head of government bond strategy at Stamford, Connecticut-based CRT Capital Group LLC. “The auction will be the theme of the day. The three-year note usually generates a lot of foreign interest and should come down well.” The yield on the benchmark 10-year note fell 3 basis points, or 0.03 percentage point, to 3.69 percent at 9:52 a.m. in New York, according to BGCantor Market Data. The price of the 3.625 percent security due in February 2020 gained 7/32, or $2.19 per $1,000 face amount, to 99 14/32. The yield was 2.86 percent a year ago today, when the Standard & Poor’s 500 Index closed at a 12-year low. Reducing the central bank’s balance sheet quickly through sales of assets would risk a sudden increase in long- term interest rates, the New York Fed’s Sack said yesterday in a speech in Arlington, Virginia. Bernanke indicated last month the Fed wouldn’t sell assets until the recovery from the recession is “more firmly established,” Sack said. Three-Year Sale The three-year notes scheduled for sale today yielded 1.430 percent in pre-auction trading, rising from 1.377 percent at the previous sale of the securities on Feb. 9. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.83 at last month’s auction, compared with an average of 2.89 for the past 10 sales. Indirect bidders, the group that includes foreign central banks, bought 51.2 percent of the debt, compared with the 10-sale average of 52 percent. The Treasury is scheduled to sell $21 billion in 10-year debt tomorrow and $13 billion of 30-year bonds on March 11. One year ago today, billionaire Warren Buffett said the economy had “fallen off a cliff.” The S&P 500 Index closed that day at the lowest since September 1996. It dropped 0.2 percent today, paring its rally in the past year to 68 percent. Treasury Losses Benchmark 10-year notes have handed investors a 3.8 percent loss in the past 12 months, according to Bank of America Merrill Lynch indexes, as U.S. shares rallied from their 2009 low. Two-year Treasury notes have outperformed longer maturities during that period as Bernanke promised to keep borrowing costs at a record low to foster the economic recovery. The notes have returned 2 percent, compared with a 14 percent loss for 30-year bonds, the indexes show. Two-year yields track the Fed’s target for overnight lending because of their shorter maturity. Longer-term yields are more influenced by the outlook for inflation. Investors may reduce holdings of shorter-dated notes in anticipation of higher rates next year and the difference in yield, or spread, between 2- and 10-year notes may narrow by about 50 basis points by year-end, said Emeric Challier, a fund manager at Avenir Finance Investment Managers in Paris. The difference was 2.82 percentage points today, after reaching a record 2.94 percentage points on Feb. 18. Pressure on Yuan The yuan is facing pressure to appreciate as speculative capital flows into the country because of a widening interest- rate differential, Yi Gang, head of the State Administration of Foreign Exchange, said at a briefing in Beijing today. China has pegged its yuan against the U.S. currency since July 2008 to help exporters weather the global recession. The central bank sells yuan and buys dollars, investing the greenbacks in Treasuries. It held $894.8 billion of the debt as of December, making China the biggest foreign holder of Treasuries. U.S. Treasuries are a “market investment” that seeks “a win-win situation with the U.S.,” Yi said. “The U.S. Treasuries market is very important for China.” The foreign-exchange reserves are “appropriately diversified,” SAFE said in a statement today. They include dollars, euro and yen, and the investments were “generally safe” in 2008 and 2009, the administration said. German Bund Spread The premium that investors demand to hold U.S. 10-year Treasuries over equivalent-maturity German bunds rose to the most since June 2007. The yield spread widened 1 basis point to 56 basis points, the most since June 14 2007, based on closing prices. Interest-rate futures on the CME Group Inc. exchange show a 38 percent chance U.S. policy makers will raise the benchmark target rate for overnight loans by at least a quarter-percentage point by September, down from 48 percent odds a month ago. The rate is currently at record low, between zero and 0.25 percent. --Editors: Dennis Fitzgerald, Greg Storey To contact the reporters on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Lukanyo Mnyanda in London at lmnyanda@bloomberg.net To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net Related Articles

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