By Cordell Eddings Dec. 21 (Bloomberg) -- The difference between 2- and 10- year Treasury notes widened to a record as investors bet an accelerating economic recovery will fuel inflation and damp demand for government debt as the U.S. borrows record amounts. The yield curve touched 281 basis points before the Treasury announce Dec. 23 how much it plans to auction in 2-, 5- and 7-year notes next week. It widened from 145 basis points at the beginning of the year, with the Federal Reserve anchoring its target rate at a record-low range of zero to 0.25 percent and the Treasury extending the average maturity of U.S. debt. Reports this week are forecast to show U.S. gross domestic product expanded in the third quarter. “Many economists are looking for 10-year yields to get above 4 percent next year due to GDP growth and concerns about supply,” said Thomas L. di Galoma, head of U.S. rates trading at Guggenheim Partners LLC, a New York-based brokerage for institutional investors. “Due to the calendar and volatility caused by very low volume there is some concern that the end-of- year auctions might not go very well.” The yield on the benchmark 10-year note climbed 11 basis points, or 0.11 percentage point, to 3.64 percent at 10:31 a.m. in New York, according to BGCantor Market Data, the highest level since Aug. 13. The 3.375 percent security due November 2019 fell 28/32, or $8.75 per $1,000 face amount, to 97 27/32. The two-year yield rose five basis points to 0.84 percent. Investors should buy the two-year note at 0.87 percent and the 10-year note near 3.64 percent as technical indicators signal Treasuries are “oversold,” William O’Donnell, U.S. government bond strategist at Royal Bank of Scotland in Stamford, Connecticut, wrote in a note to clients. RBS is one of 18 the primary dealers that trade with the Fed. Less Money The Standard & Poor’s 500 Index gained 0.9 percent. The gauge has advanced 65 percent since reaching a 12-year low in March. Government securities declined as Chinese central banker Zhu Min on Dec. 17 said that the U.S. can’t expect other nations to increase purchases of Treasuries to fund its entire fiscal shortfall. Efforts by the U.S. to cut its current-account deficit mean other nations accumulate fewer dollars through trade, leaving them with less money to buy Treasuries, Deputy Governer Zhu sid at a forum in Beijing. ‘Lot of Supply’ “The Chinese story is a reiteration of the concern that the Treasury Department might have reached its saturation point with foreign investors that have to grapple with their own internal financing problems,” said Ian Lyngen, senior government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “The Treasury has a lot of supply that needs to be taken down next year.” President Barack Obama is borrowing unprecedented amounts for spending programs. U.S. marketable debt increased to a record $7.17 trillion in November from $5.80 trillion at the end of last year. Treasury bears says yields will increase as the world’s largest economy emerges from the worst slump since the Great Depression. A Commerce Department report on Dec. 23 will show consumer spending rose 0.7 percent in November, the same as the previous month, according to the median estimate of 60 economists in a Bloomberg survey. ‘Probably Likely’ “Household spending appears to be expanding at a moderate rate,” the Federal Open Market Committee said in a statement on Dec. 16 after its meeting. Interest rate futures show a 44 percent chance the Fed will raise the rate by June, from 31.4 percent odds a month ago. The gap between yields on Treasuries and so-called TIPS due in 10 years, a measure of the outlook for consumer prices, closed above 225 basis points for four days last week, the longest stretch since August 2008. That’s the low end of the range in the five years before Lehman Brothers Holdings Inc. collapsed, and shows traders expect inflation rather than deflation in coming months, said Jay Moskowitz, head of TIPS trading at CRT Capital Group LLC in Stamford, Connecticut. Fed Chairman Ben S. Bernanke has cited a tame inflation outlook for keeping the target interest rate for overnight loans between banks at a record low range of zero to 0.25 percent. TIPS show the improving economy may change sentiment and spark further bond declines. “It could be an environment where we see 4 percent on 10- year yields, which we think is probably likely in the near term,” said Carl Lantz, an interest-rate strategist in New York at Credit Suisse Group AG, one of the 18 primary dealers of U.S. government securities that trade with the Fed. The 10-year breakeven rate was little changed at 230 basis points today, up from 9 basis points on the last trading day of 2008. To contact the reporters on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Lukanyo Mnyanda in London at lmnyanda@bloomberg.net

Source