Treasuries declined for a third day, after the price of protecting against losses on U.S. government securities surged, as a worldwide rally in stocks reduced demand for debt. The extra yield 30-year bonds offer over two-year notes was near a record, indicating money managers are demanding compensation for the risk of quicker inflation. Morgan Stanley said its “base case” is for yields to rise as investors anticipate higher costs in the economy and the Federal Reserve concludes its bond-buying program. The cost to protect Japanese bonds against losses using credit-default swaps also climbed. “There’s an unwinding of the flight to quality,” said Kazuaki Oh’e, a bond salesman in Tokyo at CIBC World Markets Japan Inc., a unit of Canada’s fifth-largest lender. “The global economy is recovering.” Ten-year yields increased two basis points to 3.38 percent as of 7:15 a.m. in London, according to data compiled by Bloomberg. The 2.625 percent security due in November 2020 slid 1/8, or $1.25 per $1,000 face amount, to 93 22/32. The rate will rise to 3.65 percent by March 31, according to CIBC. Credit-default swaps on U.S. debt rose to 49.85 basis points yesterday, the most since Feb. 17, according to data provider CMA. The advance was the most in almost 12 months. Swaps covering Japanese government bonds advanced to a six- month high of 86.49 yesterday, CMA prices show. The contracts protect against default, making a payment to the buyer if a borrower fails to adhere to its debt agreements. Traders also use them to speculate on debt. Largest Market Japan is the world’s largest bond market, followed by the U.S., according to data compiled by Bloomberg. Together the two nations have almost $20 trillion of debt. The spread between two- and 30-year rates was 3.97 percentage points, after widening to a record 4.01 percentage points yesterday. The MSCI Asia Pacific Index of shares advanced to the highest since June 2008, following stock gains in the U.S. and Europe. European equities rose as finance ministers from the region pledged to strengthen the safety net for the area’s indebted countries. The Fed is scheduled to purchase $6 billion to $8 billion of notes due from July 2013 to December 2014 today, according to its website. The central bank announced in November it planned to purchase $600 billion of Treasuries by the middle of the year. Europe ‘Angst’ “What’s required for yields to rise is an increase in inflation expectations and a reduction in angst over Europe,” Jim Caron, global head of interest-rate strategy at Morgan Stanley in New York, wrote in a report yesterday. “If this occurs and the Fed ends its bond-purchase program by the end of June, then these will be the ingredients for yields to enter their next leg higher.” The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the securities, widened to 2.38 percentage points from 2010’s low of 1.47 percentage points in October. The five-year average is 2.09 percentage points. Investors are overly optimistic on the U.S. economy, and yields are poised to fall, said Hiroki Shimazu, an economist in Tokyo at Nikko Cordial Securities Inc., part of Sumitomo Mitsui Financial Group Inc., Japan’s third-largest publicly traded bank by assets. A government report today will show housing starts fell in December as the industry that triggered the recession struggles to recover, economists said. Stuart Miller, chief executive officer of Lennar Corp., the third-largest U.S. homebuilder by revenue, said on Jan. 11 he isn’t anticipating an improvement in customer demand. ‘Weakest Markets’ “I recommend buying U.S. bonds,” Shimazu said. “Housing is one of the weakest markets in the U.S.” Ten-year rates will drop to 3 percent by March 31, he said. Treasuries are still down in January, helping push an index of global bonds lower, on speculation Fed bond purchases combined with tax cuts approved by President Barack Obama last year will work to spur the economy. U.S. government securities have handed investors a 0.1 percent loss this month, following a 2.7 percent decline in the fourth quarter of 2010, according to Bank of America Merrill Lynch indexes. Global bonds are down 0.4 percent since the close of last year, heading for a fifth monthly loss, the indexes show. The MSCI All Country World Index of stocks has returned 22 percent since the end of August. To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net. To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net.

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