Oct. 27 (Bloomberg) -- Treasuries declined, led by two-year notes, as the government began selling $64 billion in short-term U.S. securities as part of its efforts to fund its rescue of the financial system.

Two-year note yields fell the most in almost two weeks ahead of a $34 billion sale of the notes tomorrow and a $24 billion auction of five-year debt Oct. 30. A $6 billion sale of five-year Treasury Inflation Protected Securities drew less demand than the last sale. The Federal Reserve began buying short-term corporate debt in a bid to unlock lending markets. Regional banks rallied after getting $35 billion from the U.S.

``The Fed's commercial-paper program launched today, and we had a mixture of banks making announcements that they were participating'' in the government's rescue package, said Jane Caron, chief economic strategist in Burlington, Vermont, at Dwight Asset Management Co., which oversees $70 billion. ``All of these events for the Treasury investor remind you that there will be a lot of supply coming down the road.''

The yield on the two-year note climbed 11 basis points, or 0.11 percentage point, to 1.57 percent at 4:12 p.m. in New York, according to BGCantor Market Data. The price of the 2 percent security maturing in September 2010 fell 6/32, or $1.88 per $1,000 face amount, to 100 26/32. The 10-year note's yield rose 4 basis points to 3.71 percent.

The difference in yield between two- and 10-year notes was little changed at 2.14 percentage points. The measure, or spread, may fall to 1.95 percentage points this week, according to Tom di Galoma, head of U.S. Treasury trading at Jefferies & Co., a brokerage for institutional investors in New York. That would indicate traders favor longer-term debt, less influenced by this week's auctions.

TIPS Auction

The U.S. sold $6 billion in five-year inflation-indexed securities, called TIPS, at a yield of 3.27 percent, the highest since October 1997. The bid-to-cover ratio, which compares the number of bids with the amount of securities sold, was 1.81. It was the lowest since investors bid for 1.46 times the amount offered at a sale in April 2006.

The government's auctions of two- and five-year notes later this week match the amounts of the securities sold last month.

The Treasury's debt needs have grown with the passage this month of the $700 billion financial-rescue plan, which includes buying equity stakes in banks and purchasing soured financial assets. Many investors expect the government to meet the bulk of the funding needs by issuing longer-dated securities.

``You have to be careful not to be exposed to the long end'' of the Treasury market because issuance will be concentrated in longer maturities, said Mohamed El-Erian, the co-chief executive officer of Pacific Investment Management Co. There is ``value'' in short-term government debt, he said.

Commercial Paper

El-Erian spoke in a Bloomberg TV interview from Newport Beach, California. Pimco's $129.6 billion Total Return Fund, the world's largest bond fund, last held Treasuries in December, according to the firm's Web site.

The Fed began its unprecedented program of buying short- term corporate IOUs, so-called commercial paper, directly from companies at lower rates. The central bank today set the rate it's willing to accept for 90-day unsecured commercial paper at 1.88 percent plus a 1 percentage point credit surcharge. The 90- day secured asset-backed rate was set at 3.88 percent, according to Fed data compiled by Bloomberg.

Market rates on the highest-ranked 30-day commercial paper jumped 25 basis points to 2.88 percent, according to yields offered by companies and compiled by Bloomberg. Rates on paper due in 90 days rose to 3.34 percent.

Libor `Stubbornness'

The London interbank offered rate, or Libor, that banks charge each other for three-month loans in dollars fell 1 basis point to 3.51 percent, the British Bankers' Association said.

``While three-month Libor has come down from its ridiculously high peaks, there is some stubbornness to getting it down further,'' said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG's Private Wealth Management unit in New York.

Futures on the Chicago Board of Trade show 100 percent odds the Fed will lower the target rate for overnight bank loans, now 1.5 percent, by at least a half-percentage point at its meeting Oct. 29.

At least 18 regional banks, including SunTrust Banks Inc. and Capital One Financial Corp., accepted $35 billion in government cash for preferred shares as the Treasury rolled out the second half of its $250 billion package to shore up lenders and thaw credit markets.

`Well Capitalized Enough'

Bill Gross, co-chief investment officer at Pimco, said he is buying the debt of regional banks applying for the program.

``We like the ones that are submitting applications: Key Bank and Regions and a host of others that are large enough and well capitalized enough to be admitted to the club,'' Gross said in a Bloomberg TV interview.

U.S. debt underperformed European notes as European Central Bank President Jean-Claude Trichet said he may cut interest rates next week as the financial crisis intensifies. The difference in yields between German two-year notes and U.S. notes maturing in two years fell to 1 percentage point, the lowest in more than nine months.

Gross domestic product in the U.S. shrank at a 0.5 percent annual rate in the third quarter, the most since 2001, according to the median estimate in a Bloomberg News survey. The Commerce Department reports the figure Oct. 30.

To contact the reporter on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net

Last Updated: October 27, 2008 16:20 EDT