Sept. 9 (Bloomberg) -- U.S. Treasury notes fell for the first day this week after demand at the government's $9 billion auction of 10-year securities dropped to the lowest since March. The notes yielded a higher-than-expected 4.195 percent.

Some traders and investors said gains in Treasuries the past two days pushed yields too low given expectations for increases in the Federal Reserve's target overnight lending rate between banks as soon as this month.

``A 10-year note yield at 4.15 percent is incredibly low,'' Gary Pzegeo, who manages $5.3 billion in fixed-income assets at Gannett Welsh & Kotler LLC in Boston, said before the auction. ``It doesn't reflect economic fundamentals.''

At 3:45 p.m. in New York the 4 1/4 percent note due in August 2014 declined more than 1/4, or $2.50 per $1,000 face amount, to 100 13/16, according to New York-based bond broker Cantor Fitzgerald LP. Its yield rose 4 basis points, or 0.04 percentage point, to 4.20 percent down from 4.88 percent in mid- June. The yield hit a five-month low of 4.08 percent last week.

The yield may rise to 4.40 percent by month-end, and to 4.70 percent at the end of the year, according to the median estimate of 59 economists surveyed by Bloomberg News from Aug. 30 to Sept. 8.

For every $1 of 10-year notes auctioned there were $2.12 of bids, down from $2.90 in August and the lowest since $1.81 in March. The amount sold was the smallest since November 2001.

The notes were expected to draw a yield of 4.14 percent, according to the average forecast of four bond-trading firms surveyed by Bloomberg News, and yielded 4.15 percent in pre- auction trading. Today's sale was a so-called re-opening of a 10- year note issued last month, meaning the securities had the same maturity date and coupon rate as the earlier sale.

Indirect Bidders

Indirect bidders, a group that includes foreign central banks, bought 2.9 percent of the amount sold, the lowest on record since the Treasury began providing such details in May 2003. Indirect bidders won 54.7 percent of the 10-year notes sold in August and 38.6 percent in June.

``Central banks do not like to bid for reopened securities above par,'' or a dollar price higher than 100, said Scott Gewirtz, co-head of U.S. Treasury trading at Deutsche Bank AG in New York, one of the 22 primary dealers of U.S. government securities that are obligated to bid at the auctions. ``Historically those auctions have underperformed.''

At June's 10-year reopening, indirect bids made up 38.6 percent of accepted bids, down from 43.5 percent in May. At the March reopening, indirect bidders won 19.9 percent, down from 45.3 percent in February and the smallest share until today.

Primary dealers were awarded 96.4 percent of the issue, the largest ever, according to Ward McCarthy, managing director of Stone & McCarthy Research Associates, a Skillman, New Jersey- based research firm specializing in government finance.

Last of Two

The auction is the last of two this week by the Treasury totaling $24 billion to help finance a record budget deficit. The Treasury sold $15 billion of five-year notes yesterday.

Treasury notes pared earlier declines before the auction on speculation demand would rival that at yesterday's auction. At that sale, the bid-to-cover ratio was $2.72, up from $2.64 at the last auction of five-year notes on Aug. 11 and the most since $2.91 in June.

The bid-to-cover ratio gauges demand by comparing the dollar amount of bids with the amount sold.

Note prices also declined after Jack Guynn, president of the Fed's Atlanta branch, said the central bank has scope to raise rates without restraining the economy. The Fed's current target rate is 1.50 percent. Roger Stern, head of the Fed's Minneapolis- branch, said he expects ``respectable'' gains in consumer spending.

Guynn, who doesn't vote when the central bank sets the benchmark interest rate this year, said leaving rates low might produce ``unintended consequences'' in the economy. He made the comment in an interview in his office late Wednesday.

Oil and Bonds

Yields rose even as crude oil futures surged as much as 4.6 percent on the New York Mercantile Exchange. Fed Chairman Alan Greenspan yesterday said high oil prices were curbing economic growth.

``If it were not for the very sharp rise in oil prices, we would be seeing the strong growth typical of that earlier period,'' Greenspan said in testimony before the House Budget Committee. Crude oil futures last month reached a record $48.80 a barrel. They closed at $44.61 a barrel today.

Treasuries started a rally on June 15 amid slowing job growth, consumer spending and inflation. The 10-year yield dropped to 4.08 percent last week, the lowest since April, from 4.87 percent in mid-June, even as the Fed raised the federal funds target by half a percentage point to 1.50 percent.

Treasuries had their biggest gain in three weeks yesterday after Greenspan said ``innumerable areas'' of the economy ``are doing poorly'' and inflation expectations ``have eased.''

`Soft' Assessment

Greenspan's assessment of the economy ``was pretty soft relative to what he's said in the past,'' said David Robin, managing director and interest-rate strategist at Fimat USA Inc. in New York. Greenspan ``is, in the market's view, succumbing to the realities of the data,'' Robin said. ``If that's true, it's not clear'' the Fed will raise rates at each of its meetings.

Most traders and investors expect the Fed, after Sept. 21, to refrain from raising the federal funds target at one or more of its meetings in the next several months, Robin said. Fed officials until yesterday said little to bolster that view.

Interest-rate futures indicate investors expect the Fed will raise its interest-rate target at two of three remaining policy meetings this year. Policy makers also meet in November and December.

Federal funds futures, which indicate expectations for the average overnight rate in a given month, show traders are certain the central bank will raise the federal funds target a quarter percentage point to 1.75 percent when they meet this month. September federal funds futures yield 1.58 percent, in line with what the rate would average with a quarter-point increase on Sept. 21.

The yield on the December Eurodollar futures contract was 2.245 percent, down from 2.315 percent Friday. The contract settles at a three-month lending rate that has exceeded the Fed's target by an average 22 basis points over the past 10 years.

To contact the reporter on this story: Elizabeth Stanton in New York at estanton@bloomberg.net

Last Updated: September 9, 2004 15:47 EDT