By Anchalee Worrachate and Wes Goodman Dec. 17 (Bloomberg) -- Treasuries rose, pushing the yield spread between two- and 10-year notes to the widest in more than three decades, after Standard & Poor’s cut Greece’s debt rating and the Federal Reserve signaled interest rates will stay low. Yields fell from near a four-month high after S&P said it would take further action unless Prime Minister George Papandreou tackles the European Union’s largest budget deficit, spurring demand for the relative safety of U.S. debt. Federal Reserve policy makers yesterday reiterated a pledge to keep interest rates “exceptionally low” for an “extended period.” “The short-end of the Treasury market is a place to be,” said David Schnautz, an interest-rate strategist in Frankfurt at Commerzbank AG. “The Fed pledged to keep rates low, and people are looking for the safest place to park their money as liquidity is drying up into the year end. There’s still a lot of risk out there, and Greece is a good example for that.” Ten-year yields fell 4 basis points to 3.55 percent as of 10:20 a.m. in London, according to BGCantor Market Data. The 3.375 percent security due November 2019 rose 10/32, or $3.13 per $1,000 face amount, to 98 16/32. The yield climbed as high as 3.62 percent on Dec. 15, the most since Aug. 13, from the record low of 2.04 percent on Dec. 18, 2008. The two-year note yield declined 4 basis points to 0.79 percent. The yield difference between two- and 10-year notes rose to 277 basis points earlier, the most since at least 1977 based on closing prices. Treasuries also rose as the MSCI Asia Pacific Index of regional shares declined 0.6 percent. ‘Creditwatch Negative’ Treasury yields will climb in 2010 as the U.S. economy recovers, some investors and economists said. Ten-year yields will rise to 3.68 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. Greece’s credit rating was lowered by one level to BBB+, from A-, S&P said yesterday in a statement. The country was also put on “creditwatch negative,” signaling the company may reduce it again. The yield on the 10-year Greek bond rose 28 basis points to 5.79 percent, the highest level since March. The index of leading indicators, a gauge of the U.S. outlook for the next three to six months, advanced 0.7 percent in November after a 0.3 percent gain in October, according to the median forecast of 61 economists surveyed by Bloomberg News. The Conference Board reports the figure today. Fewer Americans filed for jobless benefits last week, and Philadelphia-area manufacturing expanded for a fifth month, other reports today may show. ‘Pick Up’ The Federal Reserve said yesterday that “economic activity has continued to pick up.” Policy makers are considering how to withdraw the more than $1 trillion they pumped into the financial system to combat the deepest recession since the 1930s. “The market may be preparing for an exit from the special facilities,” said Kei Katayama, who oversees $1.6 billion of non-yen debt in Tokyo as leader of the foreign fixed-income group at Daiwa SB Investments Ltd., a unit of Japan’s second- biggest investment bank. “There will be upward pressure on yields.” Fed policy makers cut their target for overnight loans between banks to a range of zero to 0.25 percent in December last year. Two-Year Notes Yields on the two-year notes, which tend to track the Fed’s benchmark because of their short maturity, are being anchored by the central bank’s promise to keep borrowing costs down. Longer-term yields, the so-called back end of the Treasury market, are rising as President Barack Obama borrows record amounts as he tries to sustain economic growth, increasing U.S. marketable debt to a record $7.17 trillion from $5.80 trillion at the end of last year. “We’re telling people to stay away from the back end,” James Caron, head of U.S. interest-rate strategy at Morgan Stanley in New York, said in an interview yesterday. “If there are any selling pressures that have to come into the marketplace, through supply or for other reasons, it’s going to be manifest mainly in the back end.” Morgan Stanley is one of the 18 primary dealers required to bid at the government’s debt sales. Yields indicate traders are adding to bets that inflation will quicken. The spread between yields on 10-year notes and Treasury Inflation Protected Securities, or TIPS, a gauge of trader expectations for inflation, widened to 2.31 percentage points yesterday, the most in 16 months. Frozen Markets Most of the programs the Fed implemented to restore trading in credit markets that froze last year will expire on Feb. 1 as scheduled, the central bank said following its meeting yesterday. The central bank said it will continue purchases of agency mortgage-backed securities totaling $1.25 trillion and about $175 billion of agency debt through the first quarter of 2010. “The Fed is preparing investors for the day when it does have to end its ultra-easy monetary policy,” Thomas Higgins, chief economist at Payden & Rygel, a Los Angeles-based money management company that oversees $50 billion, wrote in a report yesterday. China’s National Council for Social Security Fund announced that it plans to increase its ratio of overseas investments to 20 percent from 7 percent, the China Securities Journal reported today, citing Dai Xianglong, the fund’s chairman. China owns $798.9 billion of Treasuries, making it America’s largest creditor. The pension fund plans to invest in privately held overseas companies and overseas funds, the Beijing-based newspaper said on its Web site. The fund plans to reduce its ratio of investments in fixed-income securities and maintain its ratio of equities investments, according to the report. To contact the reporter on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net; Wes Goodman in Singapore at wgoodman@bloomberg.net.

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