Nov. 3 (Bloomberg) -- Treasuries fell on speculation the Federal Reserve will highlight the strengthening economy and maintain its pledge to keep interest rates at record lows for an extended period at the conclusion of tomorrow’s policy meeting.

The difference between 2- and 10-year Treasury note yields widened to the most in almost three months as investors sought higher returns as compensation against the risk of inflation. The Treasury is also scheduled to announce tomorrow how much it plans to raise in note and bond sales next week.

“There’s a small percentage of people that believe the Fed could change their wording tomorrow,” said Thomas Tucci, head of U.S. government bond trading at RBC Capital Markets New York, one of the 18 primary dealers that trade with the central bank. “At these levels of interest rates, people don’t want to take chances and they are taking money out of the market.”

Treasury 10-year note yields rose six basis points, or 0.06 percentage point, to 3.48 percent at 4:01 p.m. in New York, according to BGCantor Market Data. The 3.625 percent security maturing in August 2019 fell 17/32, or $5.31 per $1,000 face amount, to 101 7/32. The 30-year bond yield rose six basis points to 4.34 percent.

The two-year note yielded 0.92 percent. The so-called yield curve widened seven basis points to 2.55 percentage points, the most since Aug. 12.

Debt Sales

The government will next week sell $40 billion of three- year notes, $25 billion of 10-year debt and $16 billion of 30- year bonds, according to the average forecast of six of the primary dealers that will bid on the three auctions. The amounts would all be records, according to data compiled by Bloomberg.

“It’s a traditional back-up into long-end supply, the front-end seemingly anchored for the moment,” said William O’Donnell, U.S. government bond strategist at Royal Bank of Scotland Group Plc in Stamford, Connecticut, one of 18 primary dealers that trade with the Fed. “The pressure with supply is mostly out the curve.”

The Treasury said last month it plans to increase the average maturity of its outstanding debt from a 26-year low of 49 months reached December 2008 to between 72 and 84 months.

Bonds fell as gold prices jumped to a record after India’s central bank bought 200 metric tons of the metal from the International Monetary Fund, heightening speculation about more official purchases. Gold futures for December delivery climbed to a record $1,081.70 an ounce on the Comex division of the New York Mercantile Exchange. The previous record was $1,072 an ounce, set on Oct. 14.

“Higher inflation, lower bond prices,” said Tom di Galoma, head of U.S. rates trading at Guggenheim Securities LLC, a New-York based brokerage for institutional investors.

Policy Statement

The Federal Open Market Committee was forecast to leave its benchmark rate at a range of zero to 0.25 percent, according to all 95 economists in a Bloomberg survey. The FOMC will release its monetary policy statement around 2:15 p.m. tomorrow in Washington. A Labor Department report two days later may show the jobless rate rose to 9.9 percent in October, even as the economy returned to growth.

“It’s well in the price at this point that the Fed may alter its language, make it a little less accommodative,” said James Caron, head of U.S. interest-rate strategy at primary dealer Morgan Stanley in New York. “Does that mean that they move rates any sooner? I think it’s going to depend on one thing, and that’s the economy.”

Economic activity is still too reliant on fiscal and monetary support for the Fed to step away from policies designed to ease lending, particularly its commitment to keep interest rates near zero “for an extended period,” Tony Crescenzi, a market strategist and portfolio manager at Newport Beach, California-based Pacific Investment Management Co., wrote in a note to clients today.

Process or Event?

“The Fed will thus want to avoid giving the impression that a policy change is either in the offing or nearer than before,” Crescenzi wrote. Policy shifts should be gradual, with the central bank giving market participants an outline of key data that would provide “greater clarity on what would spur a change in policy,” thereby allowing the market to view any change as “more a process than an event,” he wrote.

The Treasury cut its estimate for government borrowing in the current quarter by 43 percent largely because of reductions in a program for helping the Fed manage its balance sheet.

Borrowing will total a net $276 billion from October through December, compared with a previous estimate of $486 billion, and it projects borrowing $478 billion in the three months to March 31, the department said in a statement yesterday in Washington. In the quarter that ended Sept. 30, the Treasury borrowed $393 billion, compared with $406 billion projected three months ago.

‘Ultimately Unsustainable’

President Barack Obama has increased the public debt to a record $7.01 trillion as he borrows unprecedented amounts to fund economic-stimulus plans. The figure is equivalent to almost half of the $14.2 trillion economy, according to data compiled by Bloomberg.

White House budget director Peter Orszag said the 2010 federal deficit will be little changed from the record $1.42 billion this year and pledged to reduce the amount of red ink without endangering the economy.

“Deficits of this size are serious and ultimately unsustainable,” Orszag said in prepared remarks at New York University. He said next year’s revenue shortfall is projected to “be about the same size,” with $9 trillion in deficits over 10 years, averaging about 5 percent of the economy.

U.S. government securities are headed for a loss of 2.6 percent in 2009, the first annual drop in a decade, according to Merrill Lynch’s U.S. Treasury Master index. German bonds returned 1.9 percent, the indexes show.

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, which reflects the outlook among traders for consumer prices, was unchanged at 2.04 percentage points. It increased to 2.13 percentage points on June 10, the highest level this year, from 0.01 percentage point on Dec. 31.

To contact the reporters on this story: Daniel Kruger in New York at dkkruger1@bloomberg.net; Susanne Walker in New York at swalker33@bloomberg.net.

Last Updated: November 3, 2009 16:03 EST