May 15 (Bloomberg) -- Treasuries may extend their biggest drop in a decade as international investors shun U.S. assets because of the dollar's decline.

Treasuries have lost 2.04 percent this year, according to indexes prepared by Merrill Lynch & Co. The dollar's 8.1 percent decline against the euro and 6.7 percent drop versus the yen is making returns even worse for international investors, who own more than half the $4.2 trillion of U.S. government bills, notes and bonds.

``There's further for the dollar to drop and that might make people even less inclined to buy Treasuries,'' said Timo Schild, an investment strategist at Frankfurt-based Deka Investments GmBH, which oversees $55 billion.

The Treasury Department today said international investors bought fewer U.S. assets in March than in February. Net purchases of stocks and bonds dropped to $69.8 billion from $90.5 billion in February. Net purchase of Treasuries slowed to $3.07 billion, the least since February 2003, from $21.9 billion. International purchases of U.S. securities peaked at $106.4 billion in October.

Benchmark 10-year notes fell for six of the past seven weeks, pushing yields up to 5.20 percent, the highest since May 2002, from 4.67 percent. The 5 1/8 percent note due May 2016 today was little changed at 99 1/2 at 9:25 a.m. in New York according to bond broker Cantor Fitzgerald LP.

`More Defensive'

The combination of the falling U.S. currency and declining bonds has left euro-based investors with losses of 14.4 percent on longer-term Treasuries. Investors in yen have losses of 12.5 percent.

Foreign investors bought an average $9.73 billion of Treasuries in January and February, compared with an average of $29.2 billion in 2005.

In the last two months, Sweden's Riksbank almost halved its dollar reserves and banks in Kuwait, Qatar and United Arab Emirates said they were increasing holdings of the euro. Russia's finance minister complained about the dollar's ``instability.''

``We're definitely more defensive,'' said Kevin Cronin, who oversees $67 billion as chief investment officer for fixed income at Putnam Investments in Boston. Rising interest rates around, higher commodity prices and the falling dollar work against Treasuries, he said in an interview last week.

Copper, Gold, Oil

Copper prices reached a record $8,000 a ton last week and gold rose above $700 an ounce for the first time since 1980. Crude oil futures soared to an unprecedented $75.35 last month.

The increase in commodities triggered more concerns about inflation, which erodes the value of fixed-coupon payments. A declining currency contributes to accelerating inflation by making imports more expensive.

International investors increased purchases of Treasuries last year and now own 52 percent of the U.S. government's debt as the Federal Reserve raised interest rates and central banks in Europe and Japan left theirs unchanged.

Analysts expect the gap in rates to narrow this year. The European Central Bank boosted its benchmark twice since December and indicated on May 4 more will come. The Bank of Japan in March said it planned to end five years of keeping interest rates at zero percent.

The decline in the dollar may spur some foreign investors to buy because it makes Treasuries cheaper. Indirect bidders, a group that includes central banks, bought 30.7 percent of the $13 billion of 10-year notes the government sold May 11, compared with the 31.4 percent average since May 2003.

Higher Rates

``The dollar has been knocked around by politics'' and reports central banks sold the U.S. currency, said David Goldman, global-head of fixed-income research at New York-based Cantor Fitzgerald. ``This is a great time to be buying U.S. bonds.'' Goldman said central bank dollar sales have been ``marginal.''

Ten-year Treasuries yield 3.2 percentage points more than similar-maturity Japanese government bonds, within 6 basis points of a 14-month high reached on May 1. U.S. notes due 2016 pay a 1.13-percentage-point premium above German bonds, compared with an average of 33 basis points this decade.

Bill Gross, manager of the world's largest bond fund for Pacific Investment Management Co., said in a May 5 interview from Newport Beach, California that he's avoiding 10-year notes because he expects foreign central banks to slow purchases of U.S. debt as they diversify their investments.

The Fed's holdings of Treasuries for foreign central banks and international accounts dropped $12 billion from the peak of $1.137 trillion in March.

``All else equal, less buying could lead to higher yields'' in the U.S. bond market, Gerry Lucas, head of Treasury strategy in New York at Banc of America Securities LLC, said last week. The firm is one of the 22 primary dealers of U.S. government securities that trade with the Fed.

To contact the reporter on this story: Michael McDonald in New York at mmcdonald10@bloomberg.net.

Last Updated: May 15, 2006 09:27 EDT