Bloomberg – Treasuries rose, pushing the two- year note yield to a record low, a day after the Federal Reserve said the economic recovery is slowing.

Benchmark 10-year note yields dropped below 2.70 percent for the first time since April 2009 as stocks fell following the central bank’s decision to reinvest maturing agency and mortgage-backed securities in Treasuries. The government is scheduled to auction $24 billion of 10-year notes today, the second of three sales this week totaling $74 billion.

“There is still demand for Treasuries with the Fed’s outlook for growth declining and the Fed getting ready to purchase bonds again,” said Martin Mitchell, head government bond trader in Baltimore at Stifel Nicolaus & Co., a brokerage firm. “Investors are reflecting on the Fed’s decision and that it may have to do more, which is weighing on stocks and will support the auction.”

The yield on the two-year note fell 2 basis points, or 0.02 percentage point, to 0.50 percent at 9:56 a.m. in New York, according to BGCantor Market Data. The price of the 0.625 percent security maturing in July 2012 gained 1/32, or 31 cents $1,000 face amount, to 100 1/4.

The 2-year note yield dropped earlier to 0.4892 percent, the lowest on record. The 10-year note yield decreased 7 basis points to 2.69 percent after falling to 2.6885 percent, the lowest level since April 2009.

Flatter Yield Curve

The difference between 10- and 2-year yields narrowed for a fifth day, falling to 2.20 percentage points, indicating the flattest yield curve on a closing basis since May 2009. The spread between 10- and 30-year debt widened to 1.26 percentage points, the most since the Treasury began regularly scheduled sales of the longer-dated securities in 1977.

The Standard & Poor’s 500 Index decreased 2 percent. The Stoxx Europe 600 Index fell 1.7 percent, following yesterday’s 0.9 percent decline.

Treasuries rallied yesterday after the Fed said it will reinvest principal payments on its mortgage holdings into long- term U.S. debt securities.

At their meeting, central bankers adopted a $2.05 trillion floor for their securities portfolio, pivoting toward a quantitative target for monetary policy.

Officials directed the New York Fed’s trading desk to reinvest what economists estimate will be $15 billion to $20 billion a month in maturing agency and mortgage-backed securities back into Treasuries. The purchases will help keep Treasury yields and mortgage costs low and prevent monetary stimulus from shrinking further.

‘Slowed’ Recovery

“The pace of recovery in output and employment has slowed in recent months,” the Federal Open Market Committee said in its statement. “Measures of underlying inflation have trended lower in recent quarters.”

The central bank said in a separate statement it will announce a purchasing schedule today and that its buying will be concentrated “in the 2- to 10-year sector” of the maturity spectrum, though it will also buy other maturities as well as Treasury Inflation Protected Securities.

The Fed kept the target rate for overnight lending between banks at zero to 0.25 percent, and retained a commitment to keep its benchmark low for an “extended period” of time.

The central bank will probably buy $300 billion to $325 billion of Treasuries in the next year, Ajay Rajadhyaksha and Dean Maki of Barclays Plc in New York wrote in an e-mail note to clients. The central bank bought $300 billion of government debt from March to October 2009.

Barclays’s View

Purchases will be skewed toward intermediate maturities because rates on short-term notes are already low, according to Barclays, one of the 18 primary dealers that are required to bid at the government debt sales.

Futures contracts on the CME Group Inc. exchange show a 25 percent chance policy makers will boost the target rate for overnight lending between banks at least a quarter-percentage point by June 2011, down from 61 percent odds a month ago.

The gain in Treasuries was tempered as investors prepared for today’s 10-year note sale, said Skye Masters, an interest- rate strategist at Royal Bank of Scotland Group Plc in Sydney.

“That’s one thing that limited the extent to which Treasuries could rally,” Masters said. A sustained drop in yields below 2.75 percent may lead to further declines to 2.66 percent, according to Masters.

The 10-year securities scheduled for sale yielded 2.727 percent in pre-auction trading, compared with 3.119 percent at the previous sale of the notes on July 13.

Ten-year notes, among the most sensitive to inflation, are outperforming shorter-maturity debt as consumer prices fall. The securities have returned 11.3 percent this year, compared with 7.1 percent for the broader market, according to Bank of America Merrill Lynch indexes.

Consumer prices excluding food and energy rose 0.9 percent in July from a year earlier, holding at a 44-year low, economists said before the Labor Department report on Aug. 13.

To contact the reporters on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net; Cordell Eddings in New York at ceddings@bloomberg.net

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