Nov. 21 (Bloomberg) -- Treasury two-year note yields fell to the lowest level this year on concern the rally in risk assets has outpaced growth prospects and as Federal Reserve officials signaled interest rates will remain near zero.

Three-month bill rates turned negative on Nov. 19 for the first time since last year’s credit freeze as a 62 percent rally in the Standard & Poor’s 500 Index from a 12-year low in March pushed valuations to about 22 times its companies’ earnings, the highest level since 2002. The minutes of the Fed’s Nov. 4 Federal Open Market Committee meeting will be released Nov. 24.

“Investors are trying to lock in a good year and are reversing risk positions,” said Michael Pond, an interest-rate strategist in New York at Barclays Plc, one of the 18 primary dealers that trade directly with the Fed. “They are not taking new risks as they go into year-end.”

The two-year note yield touched 0.67 percent yesterday, the lowest level since December. It fell nine basis points on the week, the most since the five days ended Oct. 30, to 0.72 percent, according to BGCantor Market Data. The 1 percent note due in October 2011 rose 5/32 this week, or $1.56 per $1,000 face amount, to 100 17/32.

The three-month bill rate was 0.005 percent, down five basis points, or 0.05 percentage point, for the week, according to Bloomberg data. The 10-year yield fell six basis points to 3.36 percent on the week.

Bill rates were negative last December for the first time since the government began selling the securities in 1929 as investors sought to preserve their principal following the collapse of Lehman Brothers Holdings Inc.

Bullard Comments

Fed Bank of St. Louis President James Bullard said on Nov. 18 that experience indicates policy makers may not start to increase borrowing costs until early 2012.

“If you look at the last two recessions, in each case the FOMC waited two and a half to three years before we started our tightening campaign,” Bullard said in a speech in St. Louis. “If we took that as a benchmark, that would put us in the first half of 2012.”

Bullard’s comments followed a Nov. 16 speech by Chairman Ben S. Bernanke in which he indicated that the central bank’s extended period of low borrowing costs may be even longer amid economic “headwinds.”

“There have been recent comments from a lot of people at the Fed hinting that they may not hike for a long, long time,” said Ajay Rajadhyaksha, head of U.S. fixed-income strategy in New York at Barclays. “That’s why the two year has gotten the support it has.”

Consumer Prices

The Fed cut its target for overnight lending between banks to a range of zero to 0.25 percent in December and repeated that pledge on Nov. 4 at the end of a two-day meeting.

At that time, Fed officials also specified for the first time that policy will stay unchanged as long as inflation expectations are stable and unemployment fails to decline. They said businesses are reducing staffing and investment “at a slower pace” and household spending appears to be growing slowly.

Consumer prices rose 0.3 percent last month, according to figures from the Labor Department on Nov. 18. Economists forecast the consumer price index would rise 0.2 percent, according to the median of a Bloomberg News survey.

A report on Nov. 17 showed producer prices increased less than forecast in October. The 0.3 percent increase in prices paid to factories, farmers and other producers was smaller than forecast and followed a 0.6 percent drop in September, according to Labor Department data.

‘Dovish Stance’

“The emphasis on low inflation and economic slack solidifies the message once again that the Fed’s dovish stance of a lower-for-longer policy with respect to rates is here to stay,” said John Spinello, chief technical strategist in New York at primary dealer Jefferies Group Inc.

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, widened to 2.19 percentage points yesterday from about zero at the end of last year. The figure is in line with the five-year average.

The Treasury will auction a record $118 billion of 2-, 5- and 7-year notes on three consecutive days beginning Nov. 23.

Treasury Purchases

Foreign purchases of U.S. debt totaled $44.7 billion in September compared with purchases of $28 billion a month earlier, according to Treasury data released on Nov. 17.

China remained the biggest foreign holder of U.S. Treasuries, after its holdings rose $1.8 billion to $798.9 billion, according to data from the Treasury Department’s Treasury International Capital report. Japan, the second-largest holder, increased its holdings $20.3 billion to $751.5 billion.

U.S. marketable debt totaled $6.95 trillion in October, after climbing to a record $7.01 trillion in September as President Barack Obama borrows unprecedented amounts to fund spending programs and service record deficits.

Two-year notes, among the most sensitive to Fed interest rates because of their short maturity, returned 1.65 percent this year through Nov. 19, according to indexes compiled by Bank of America’s Merrill Lynch unit. Ten-year notes, which are more sensitive to inflation, have fallen 6.4 percent.

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net.

Last Updated: November 21, 2009 00:00 EST