By Susanne Walker and Anchalee Worrachate Dec. 17 (Bloomberg) -- Treasuries gained as the dollar rose to a three-month high against the euro and stocks declined after Standard & Poor’s cut Greece’s credit rating, spurring demand for the relative safety of government debt. Two-year notes rose for a third day after Federal Reserve policy makers reiterated a pledge to keep interest rates “exceptionally low” for an “extended period” at the end of their two-day policy meeting yesterday. S&P yesterday said it would take further action unless Prime Minister George Papandreou tackles the European Union’s largest budget deficit. More Americans than anticipated filed first-time claims for jobless benefits last week, a Labor Department report showed. “The dollar is stronger and stocks are down quite a bit,” said Dan Mulholland, a Treasury trader in New York at RBC Capital Markets, one of 18 primary dealers that trade with the Fed. “There’s a flight to quality trade from Greece because of the downgrades.” Ten-year yields fell seven basis points to 3.53 percent at 8:33 a.m. in New York, according to BGCantor Market Data. The 3.375 percent security due November 2019 rose 17/32, or $5.31 per $1,000 face amount, to 98 23/32. The yield touched 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 four basis points to 0.79 percent. The yield difference between 2- and 10-year notes touched 278 basis points, the most on an intraday basis since June 5. ‘Extra Risk Premium’ “People are going to be concerned that as long as the data remains relatively strong, although the Fed is on this exit strategy path, they are a long way from raising actual interest rates so there’s going to be some extra risk premium put into the back end,” said Dominic Konstam, head of interest-rate strategy at primary dealer Credit Suisse Securities USA LLC in New York, in an interview on Bloomberg Radio. Initial jobless claims rose by 7,000 to 480,000 in the week ended Dec. 12, from a revised 473,000 the prior week, Labor Department figures showed today in Washington. The number of people receiving unemployment insurance was little changed in the prior week, while those getting extended payments increased. Futures on the Standard & Poor’s 500 Index fell 0.6 percent. Analyst Meredith Whitney cut earnings estimates for Goldman Sachs Group Inc. and Morgan Stanley through 2011. Greece’s credit rating was lowered by one level to BBB+, from A-, S&P said yesterday in a statement. S&P also put the country on “creditwatch negative,” signaling its rating may be reduced again. The yield on the 10-year Greek bond rose 28 basis points to 5.79 percent, the highest level since March. $7.17 Trillion “Sovereign nations have borrowed too much money with relation to GDP, so that’s what’s impacting the ratings agencies downgrade,” said Thomas L. di Galoma, head of U.S. rates trading at Guggenheim Partners LLC, a New York-based brokerage for institutional investors. The Fed said yesterday that “economic activity has continued to pick up” and “deterioration in the labor market is abating.” Policy makers cut their target for overnight loans between banks to a range of zero to 0.25 percent in December last year to combat the worst slump since the Great Depression. Yields on 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. ‘Ultra-Easy’ 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. The Fed also 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 next year. 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 Fed 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. Inflation Bets 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. Ten-year yields will reach 3.68 percent by the middle of next year as the U.S. economy recovers, according to a Bloomberg survey of banks and securities companies with the most recent forecasts given the heaviest weightings. To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net; Anchalee Worrachate in London at aworrachate@bloomberg.net.

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