Aug. 21 (Bloomberg) -- U.S. 10-year Treasury note yields were near the lowest level in five weeks before a Federal Reserve report that economists estimate will show manufacturing in the Philadelphia region fell for a ninth month.

Two-year note yields traded near the lowest since May 12 as traders bet economic growth will slow and credit-market losses will widen. Lehman Brothers Holdings Inc. fell in German trading after the Financial Times said two banks in Asia have abandoned talks to buy a stake in the investment bank. Standard & Poor's 500 index futures fell.

``We'll continue to see the data deteriorate as things play out,'' said Martin Mitchell, head government bond trader at the Baltimore unit of Stifel Nicolaus & Co. It's the ``general nervousness out there that takes the market a little higher.''

The yield on the benchmark 10-year note dropped 2 basis points to 3.79 percent by 8:03 a.m. in New York, according to bond broker BGCantor Market Data. The price of the 4 percent security due in August 2018 rose 4/32, or $1.25 per $1,000 face amount, to 101 23/32. A basis point is 0.01 percentage point.

Two-year note yields were little changed at 2.25 percent.

The Philadelphia Fed's economic index, a gauge of regional manufacturing, improved to minus 12.6 in August from minus 16.3 in the prior month, according to the median forecast of 62 economists surveyed by Bloomberg News. Negative readings signal a decline.

``Treasury rates will drop further,'' said Tsutomu Komiya, an investment manager in Tokyo at Daiwa Asset Management Co., a unit of Japan's second-largest brokerage, overseeing the equivalent of $88.5 billion. ``The economic situation isn't good.'' The rally may pick up in September after the U.S. sells two- and five-year notes next week, he said.

Slowing Economy

Separate reports today will show the Conference Board's index of leading indicators fell in July and initial claims for jobless benefits declined last week, Bloomberg surveys show.

``What we're seeing in the next year is a very slow-growing economy that ultimately will probably be described as a recession,'' Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc., said yesterday on Bloomberg Radio. ``You're going to see inflation come down, we think, quite dramatically'' because of declining oil prices.

Lehman is one of the 19 primary dealers that trade directly with the U.S. central bank.

MSCI's Asia Pacific Index dropped 0.9 percent and Europe's Dow Jones Stoxx 600 Index slipped 0.8 percent in London. Futures on the Standard & Poor's 500 Index fell 0.5 percent.

Fannie and Freddie

Yields also slid on increased speculation the government will take over mortgage-finance providers Fannie Mae and Freddie Mac. Shares in the two companies tumbled in New York trading to the lowest levels since at least 1990. Writedowns and credit losses at banks and securities companies since the start of 2007 have totaled more than $500 billion.

The Bank of Korea said it sees no problem in recovering its principal investments in bonds issued by Fannie Mae and Freddie Mac. There is ``no chance'' the U.S. will buy back the senior bonds on a discount if it decides to bail out the mortgage- finance companies, the central bank said in a statement today.

The yield spread on Fannie Mae 10-year securities narrowed to 69 basis points more than Treasuries from 86 basis points two days ago.

Treasuries also gained after the Financial Times reported Lehman was unable to reach an agreement to sell a stake to South Korean and Chinese investors.

Treasury Auction

Two-year rates declined to within about a quarter- percentage point of the Fed's 2 percent target for overnight bank lending, curtailing demand among some investors.

``It's hard to see an aggressive rally from here,'' said Adam Donaldson, the Sydney-based head of debt research at Commonwealth Bank of Australia, the nation's second-largest lender. ``You can get a flight to quality and it might take yields lower, but for it to be sustained you really need to see it backed up by a view the Fed is about to do some more easing, and we don't think they're going to come through with that.''

Yields on debt due in 2010 will be 2.3 percent to 2.4 percent for the next six months, Donaldson said. Three months ago, he correctly forecast the rate would fall to current levels.

The central bank will raise its rate by at least a quarter point in January, futures contracts on the Chicago Board of Trade indicate.

Fed Chairman Ben S. Bernanke is scheduled to speak about financial stability tomorrow as part of Fed Bank of Kansas City's annual symposium in Jackson Hole, Wyoming.

U.S. economic growth will slow to 0.4 percent in the fourth quarter, according to a Bloomberg survey of economists. It was 1.9 percent in the second, according to the most recent Commerce Department figures.

To contact the reporter on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net; Wes Goodman in Singapore at wgoodman@bloomberg.net.

Last Updated: August 21, 2008 08:09 EDT