By Theresa Barraclough March 16 (Bloomberg) -- Treasury 10-year yields were near the lowest level in a week on speculation the struggling housing market will prevent the Federal Reserve from raising interest rates for much of 2010. The difference in yields between two- and 10-year notes was near the narrowest since February before a government report that economists said will show housing starts and building permits both fell last month. Concern the economic recovery is losing momentum may spur the Fed to retain language in its policy statement today that the target lending rate should remain at virtually zero for an “extended period.” “If yields go up, it’ll damage the housing market and drag on the economy, so the Fed cannot raise rates,” said Kazuaki Oh’e, a bond salesman in Tokyo at Canadian Imperial Bank of Commerce, the nation’s fifth-largest lender. “The earliest they will raise rates is in the fourth quarter.” The 10-year note yielded 3.70 percent as of 6:34 a.m. in London, according to BGCantor Market Data. The 3.625 percent security due February 2020 traded at 99 13/32. The yield hasn’t been lower than 3.68 percent since March 9. Ten-year yields declined six basis points during the two days after the Federal Open Market Committee’s last meeting ended on Jan. 27. The spread between two- and 10-year yields, known as the yield curve, was near the narrowest in six weeks on concern the housing market, which triggered the worst recession in seven decades, remains weak. The gap was 2.75 percentage points today. It shrank to 2.73 percentage points on March 5, the narrowest since Feb. 1. Focus on Fed The central bank will today keep its benchmark at a record low zero to 0.25 percent, where it has been since December 2008, according to all 90 economists surveyed by Bloomberg. Policy makers plan to end purchases of $1.25 trillion of mortgage- backed securities this month. “The focus will be on whether the wording that rates will be on hold for an ‘extended period’ is maintained,” said Rob Henderson, a senior economist in Melbourne at National Australia Bank Ltd., the nation’s biggest lender. “Probably, but perhaps with some dissent.” Futures on the CME Group Inc. exchange showed an 84 percent chance policy makers will keep their target lending rate unchanged or cut it by their June meeting, up from 82 percent odds a month earlier. New Homes Housing starts fell to a 570,000 annual pace last month, a 3.6 percent decline from January, according to the median forecast of economists surveyed by Bloomberg before today’s Commerce Department report. Building permits, a sign of future construction, declined 3.4 percent to a 601,000 pace, a separate Bloomberg survey showed. U.S. 30-year fixed mortgage rates slid to 5.06 percent yesterday, from 5.03 percent a week ago, according to Bankrate.com in North Palm Beach, Florida. The Fed is buying $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt to support mortgage lending and the housing market. The central bank plans to complete the purchases this month, it said after its last meeting on Jan. 27. Any gain in Treasuries may be tempered on speculation China will keep selling the securities to diversify its foreign- exchange reserves. The largest holder of U.S. debt has been a net seller of Treasuries for three straight months, the longest such stretch since the end of 2007. Chinese officials have questioned the dollar’s role as a reserve currency and recently sought assurances about the safety of U.S. debt as the budget deficit widens to a projected record $1.6 trillion this year. ‘Dire Implications’ China’s holdings dropped by a net $5.8 billion to $889 billion in January, according to Treasury Department data released yesterday in Washington. Japan cut its holdings $300 million to $765.4 billion, the report showed. “Foreign central banks stopped buying Treasuries in January,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “If this were to continue, if China were to stop recycling its dollars into U.S. Treasuries, it could have dire implications for Main Street America in that mortgage rates could move higher.” Traders have been cutting their outlook for inflation over the next 10 years before a Labor Department report tomorrow that may show producer prices fell last month. “The inflation environment looks very benign in the near term,” Andrew Tilton, an economist at Goldman Sachs Group Inc. in New York, wrote in a report yesterday. Wholesale prices dropped 0.2 percent in February, after gaining 1.4 percent in January, according to a Bloomberg survey. A report March 18 will show consumer-price inflation slowed to 0.1 percent, from 0.2 percent in January, another survey showed. The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of expectations for inflation known as the breakeven rate, narrowed to 2.25 percentage points today, from this year’s high of 2.49 percentage points reached Jan. 11. The average over the past five years is 2.16 percentage points. To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net.

Source