By Theresa Barraclough Dec. 22 (Bloomberg) -- Treasuries dropped, pushing 10-year yields to the highest level in four months, on prospects the U.S. government’s final figure for third-quarter gross domestic product will signal faster inflation. The yield curve, the gap between shorter- and longer-term debt used as a barometer for the economy, widened to a record as investors bet an accelerating recovery will fuel inflation and hurt demand for unprecedented government debt sales. Government securities extended yesterday’s losses, the largest drop since August, before the U.S. tomorrow announces the sizes of two-, five- and seven-year auctions next week. “Inflation fears are being sparked by oil price gains,” said Kazuaki Oh’e, a bond salesman in Tokyo at Canadian Imperial Bank of Commerce, the nation’s fifth-largest lender. “The trend has changed from deflation to neutral and that is damaging the bond market.” The yield on the benchmark 10-year note rose 4 basis points, or 0.04 percentage point, to 3.72 percent, as of 8:05 a.m. in London, according to BGCantor Market Data. It climbed earlier to 3.73 percent, the highest level since Aug. 13. The 3.375 percent security due November 2019 fell 11/32, or $3.44 per $1,000 face amount, to 97 5/32. The two-year yield added 3 basis points to 0.89 percent. The difference between 2- and 10-year Treasury note yields increased to as much as 285 basis points today. It rose from 145 basis points at the beginning of the year, with the Federal Reserve anchoring its target rate at virtually zero and the U.S. extending the average maturity of its debt. The yield curve reached its previous record of 281 basis points on June 5, when Treasuries plunged after a government report showed the smallest decline in U.S. payrolls in eight months. Ten-year note yields touched 4 percent the following week, the highest level in 2009. Economy Expanding The world’s largest economy expanded at a 2.8 percent annual rate, matching last month’s estimate, according to economists surveyed by Bloomberg before today’s Commerce Department report. “If you are going to have a recovery you are going to have higher inflationary pressures, so the curve should continue to steepen from here,” said Dan Greenhaus, chief economic strategist at Miller Tabak & Co. “The curve could reach 300 to 325 basis points.” Inflation Expectations The gap between yields on Treasuries and so-called TIPS due in 10 years, a measure of the outlook for consumer prices, climbed to 2.36 percentage points today, the most since July 2008. “There’s more pressure on the bond market as we have the last auctions of the year next week,” CIBC’s Oh’e said. “It’s a very illiquid market at the moment” because of the holidays. The U.S. plans to sell two-year notes on Dec. 28, five-year notes on Dec. 29 and seven-year bonds on Dec. 30. The package will total $118 billion, according to Wrightson ICAP LLC, an economic advisory firm in Jersey City, New Jersey. “There is more of a risk of further steepening going forward, especially with the amount of auctions occurring at the end of the year, a time when the market will have very little volume,” said Larry Milstein, managing director in New York of government and agency debt trading at RW Pressprich & Co., a fixed-income broker and dealer for institutional investors. 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. Return or Loss Treasuries of all maturities have fallen 3 percent this year through yesterday, while holders of Japanese debt have made a 1.1 percent return, according to Bank of America Corp. Merrill Lynch indexes. The yield differential between 10-year U.S. and Japanese government debt expanded to 2.49 percentage points today, the widest in more than a year, according to data compiled by Bloomberg. The gap has swelled from 1.02 percentage points at the end of last year. Demand for Treasuries has also waned as Chinese central banker Zhu Min on Dec. 17 said the U.S. can’t expect other nations to increase purchases of Treasuries to fund its fiscal shortfall. “The lack of data in the past 24 hours, thin trading conditions and search for direction or macro themes in 2010, implies the current weakness has been partially influenced by a delayed reaction to Zhu Min’s comments,” said Geoff Howie, an economist and broker at MF Global Singapore Ltd., part of the world’s largest broker of exchange-traded futures and options. To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net

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