Nov. 7 (Bloomberg) -- U.S. 10-year Treasuries headed for the biggest weekly advance in eight months before a government report that will probably show the U.S. lost the most jobs since 2003 in October.

The gains have pushed two-year yields to near the lowest level since March as the economic slowdown prompted central banks to accelerate interest-rate reductions and boosted the odds for more cuts by the Federal Reserve. The difference in yield between two- and 10-year notes was at the widest in almost five years, steepening 23 basis points in the last two weeks.

``There's a lot of steam left in Treasuries,'' said Stuart Thomson, who helps manage $46 billion in bonds at Resolution Investment Management Ltd. in Glasgow, Scotland. `` We're still in a situation where markets are underestimating the depth of the U.S. downturn.''

The two-year note yield was little changed at 1.29 percent as of 6:55 a.m. in New York, near the lowest level since March 17, according to BGCantor Market Data. The 1.5 percent security due October 2010 traded at 100 13/32.

The yield dropped 27 basis points this week, the most since the period ended June 27. The 10-year yield fell 26 basis points to 3.69 percent, the most since Feb. 29. A basis point is 0.01 percentage point.

The yield on the 10-year note will fall to 3.5 percent by year-end and that on the two-year security will drop to 1 percent, Thomson said.

Falling Rates

The Bank of England yesterday reduced interest rates by a bigger-than-forecast 150 basis point to 3 percent, the lowest since 1955, followed by a 50 basis-point cut to 3.25 percent by the European Central Bank.

Standard & Poor's 500 Index of stocks plummeted 10 percent since Nov. 4, adding to demand for the safest assets.

``Its heaven for bonds really, it can't get any better than that,'' said Luca Jellinek, a London-based strategist at Royal Bank of Scotland Group Plc. ``We're in a downward trending economic environment and it will continue to benefit Treasuries.''

Futures on the Chicago Board of Trade show an 84 percent chance the Fed will reduce its target rate for overnight bank loans by half a percentage point to 0.5 percent on Dec. 16, rising from 55 percent odds a week ago.

``Yields should be dramatically lower,'' said Satoshi Okumoto, a general manager in Tokyo at Fukoku Mutual Life Insurance Co., which has $58.5 billion in assets. ``Jobs will be weak. The Fed has to cut rates. It's quite a good time to buy.''

Zero Fed Funds

The Fed will cut the rate to zero percent, bringing two- year yields to less than 1 percent, next year, Okumoto said.

Today's Labor Department figures will show U.S. payrolls shrank by 200,000 workers, the biggest decline since March 2003, according to the median forecast in a Bloomberg News survey of economists. The jobless rate climbed to a five-year high of 6.3 percent, the survey shows. The figures are due at 8:30 a.m. in Washington.

Economic indicators have ``turned decidedly negative,'' Fed Governor Kevin Warsh said yesterday in New York. Data suggest the economy will probably be ``weak'' this quarter, he said.

The Treasury this week said it plans to sell the most debt since 2004 this quarter and bring back auctions of three-year notes as a slowing economy swells the federal budget deficit to a record level.

The government said it projects fourth-quarter borrowing needs to grow to $550 billion, up from an earlier estimate of $142 billion, and to $368 billion in the first quarter of 2009 as it looks to fund a growing deficit and the financial-rescue package.

`Too Much Supply'

``Obama will come in, guns blazing, trying to get this economy on track,'' David Keeble, the London-based head of fixed-income strategy at Calyon, said in an interview with Bloomberg Television. ``You've got to start thinking about supply. There's too much supply already.''

The difference in yield between two- and 10-year notes was 2.39 percentage points, near to the five-year high of 2.48 percentage points on Nov. 3.

Declining money-market rates indicate banks are becoming more willing to lend, curbing appetite for the relative safety of government securities.

The difference between what banks and the Treasury pay to borrow for three months, the so-called TED spread, narrowed to 1.99 percentage points, from 4.64 percentage points on Oct. 10, which was the most since Bloomberg data began in 1984.

TIPS `Attractive'

A contraction in the U.S. is curbing price gains in the economy, making inflation-protected bonds ``very attractive,'' fixed-income strategist Michael Brandes and researcher Steve Reich at Citi Private Bank in New York wrote in a report issued yesterday. Citi is part of Citigroup Inc., the biggest U.S. lender.

The difference between rates on 10-year Treasury Inflation Protected Securities, or TIPS, and conventional securities narrowed to 0.91 percentage point, from 2.26 percentage points three months ago. The difference represents traders' outlook for inflation for the next decade.

Treasuries have returned 5.9 percent this year versus 9.06 percent for all of 2007, according to Merrill Lynch & Co.'s U.S. Treasury Master index.

The gain was 7.2 percent in Germany, 3.2 percent in the U.K., and 1.4 percent in Japan, the Merrill figures show, fueled by the spreading financial-market turmoil. The International Monetary Fund predicted yesterday the U.S., Japan and euro region will enter a recession next year

To contact the reporters on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net; Wes Goodman in Singapore at wgoodman@bloomberg.net

Last Updated: November 7, 2008 06:56 EST