Nov. 3 (Bloomberg) -- Treasuries rose, pushing two-year note yields down the most in a week, as reports showed lending standards were the tightest on record and manufacturing dropped to the lowest level in 26 years.

Government bonds gained as traders boosted bets the Federal Reserve will cut the key interest rate to 0.5 percent. Other reports this week are forecast to show payrolls declined and the unemployment rate jumped. The difference in yield between two- and 10-year notes reached the highest in almost five years as the Treasury's estimate of its fourth-quarter borrowing needs more than tripled, to $550 billion.

``People are still clinging to their security blanket and the front end of the Treasury curve,'' said Robert Tipp, chief investment strategist for fixed income in Newark, New Jersey, at Prudential Investment Management, which oversees more than $200 billion of bonds. ``They are going to be wondering: how ungodly is the data? Is it just briefly so, or does it get that way and stay?''

Two-year note yields dropped 11 basis points, or 0.11 percentage point, to 1.45 percent at 4:14 p.m. in New York, according to BGCantor Market Data. It was the biggest decrease since they fell 13 basis points Oct. 24. The price of the 1.5 percent security maturing in October 2010 gained 7/32, or $2.19 per $1,000 face amount, to 100 3/32.

Yields on 10-year notes fell 5 basis points, the first decline in six days, to 3.92 percent.

`Tightening Standards'

A survey of senior loan officers showed many at domestic banks ``again reported tightening standards on both credit card and other consumer loans,'' the Fed said today. ``Almost all domestic and foreign respondents pointed to a less favorable or more uncertain economic outlook as a reason for tightening their lending standards'' on commercial and industrial loans in the past three months, the central bank said.

A Treasury survey of primary dealers of government securities showed expectations the federal budget deficit this year will reach $988 billion.

The difference in yield between two- and 10-year notes was 2.47 percentage points, the most since January 2004.

``I expect to see some kind of bearish steepening this week,'' said Carl Steen, a market analyst in New York at MFR Inc., an economic consulting firm. Shorter-term securities ``will continue to be anchored by monetary policy. The long end will sell off on supply.''

Fourth-Quarter Borrowing

The yield spread may grow to 3 percentage points by the end of the first quarter of 2009, according to James Caron, head of U.S. interest-rate strategy at Morgan Stanley in New York, one of 17 primary dealers that trade with the Fed. Analysts at Credit Suisse Holdings USA Inc., another primary dealer, also forecast the so-called yield curve to approach 3 percentage points.

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

The U.S. is scheduled on Nov. 5 to announce the amount of Treasuries it plans to auction. It may sell a net $388 billion of bills, notes and bonds this quarter, up from $178.4 billion in the previous three months and $33.4 billion in the same period of 2007, according to a quarterly survey by the Securities Industry and Financial Markets Association released Oct. 31.

Economic Reports

The government has room to boost borrowing if history is any indication, wrote Tobias Levkovich, Citigroup Inc.'s chief U.S. equity strategist. Federal debt as a percentage of gross domestic product, at 36.8 percent as of June 30, is below the 49.2 percent reached in the mid-1990s, Levkovich wrote in a report today, citing Fed data.

The Institute for Supply Management's U.S. factory index, a gauge of manufacturing, dropped in October to 38.9, the lowest level since September 1982, the Tempe, Arizona-based group reported today. A reading of 50 is the dividing line between expansion and contraction.

A Labor Department report on Nov. 7 will show payrolls shrank by 200,000 workers last month, according to the median forecast in a Bloomberg News survey. The unemployment rate may jump to its highest level in more than five years.

Futures on the Chicago Board of Trade show a 61 percent chance the Fed will reduce its 1 percent target rate for overnight bank loans to 0.5 percent at its Dec. 16 meeting, compared with no chance a week ago. The remaining bets are for a cut to 0.75 percent.

`Choked Off' Growth

The U.S. economy may be stagnant through the end of next year, hurt by tight credit conditions, while inflation pressures ease, Dallas Fed President Richard Fisher said.

``My forecast is I don't see any economic growth through 2009,'' Fisher said in a Bloomberg Television interview. ``The credit crisis reached up and grabbed the throat of the global economy and choked off economic growth.''

The next president may find foreign investors, the biggest U.S. creditors, unable to absorb a growing supply of Treasury bonds as the financial crisis prompts nations to invest in their own banks and currencies.

To contact the reporters on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net; Cordell Eddings in New York at ceddings@bloomberg.net

Last Updated: November 3, 2008 16:19 EST