May 29 (Bloomberg) -- Treasuries headed for their second monthly loss, pushing 10-year yields up the most in almost six years, as President Barack Obama’s record borrowing spree overwhelmed Federal Reserve efforts to cap interest rates.

Notes, little changed today, also tumbled this week on speculation the worst of the economic recession is over. A private report today will show confidence among U.S. consumers gained in May for a third month, economists said. South Korea’s National Pension Service, the nation’s largest investor, plans to reduce the weighting of U.S. bonds in its holdings, the government said in a statement.

“It’s a disastrous market,” said Hideo Shimomura, who oversees $4 billion in non-yen bonds as chief fund investor at Mitsubishi UFJ Asset Management Co. in Tokyo, a unit of Japan’s largest bank. “I expected yields to rise but not this fast. We will see new highs in yields.”

The benchmark 10-year note yielded 3.61 percent at 6:29 a.m. in London, according to BGCantor Market Data. The 3.125 percent security due in May 2019 traded at a price of 95 30/32.

Ten-year rates rose about half a percentage point in May, extending an increase of 46 basis points in April. The two-month climb was the most since July and August of 2003. A basis point is 0.01 percentage point.

The difference between two- and 10-year rates widened to a record 2.76 percentage points on May 27, before narrowing to 2.66 percentage points today.

Merrill Lynch & Co.’s MOVE Index, which measures volatility in Treasuries, rose to 167.50 as of yesterday, approaching the highest level this year.

Korean Fund

The Korean fund plans to reduce its exposure to U.S. Treasuries and diversify its overseas investment with alternatives such as credit bonds, the government statement said.

Corporate bonds and other credit-market instruments are rallying as signs of recovery in the economy feed demand for higher-yielding assets. The Reuters/University of Michigan final index of consumer sentiment increased to 68, the highest since September, according to the median estimate of 53 economists in a Bloomberg News survey before the report today.

Merrill’s U.S. Corporate & High Yield Master index has returned 7.8 percent so far this year, while sovereign securities handed investors a 5.1 percent loss, based on the company’s U.S. Treasury Master index.

The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, was 53 basis points, close to the least since August 2007.

Bond Risk

The cost of protecting Asia-Pacific bonds from default declined today. Markit iTraxx’s Japan index of credit-default swaps fell 7 basis points to 1.77 percentage points, according to Morgan Stanley prices.

Credit-default swaps, contracts to protect against or speculate on default, pay the buyer face value if a company fails to adhere to its debt agreements.

Gains in stocks helped erode demand for the relative safety of government debt. The MSCI Asia Pacific Index for stocks added 0.6 percent today. Japan’s 10-year bonds were set to complete a three-month decline, the longest slump since April 2006, on concern investors will struggle to absorb increases in government debt.

Treasuries gained yesterday on speculation unemployment at the highest level in a quarter century will keep yields from climbing further.

Jobless Rate

The U.S. jobless rate rose to 9.2 percent in May, the most since 1983, according to the median forecast in a Bloomberg News survey of economists before the Labor Department reports the figure on June 5. Revlon Inc., the cosmetics maker controlled by financier Ronald Perelman, said yesterday it is cutting 400 jobs.

“The economic backdrop is still for a protracted exit from the recession and for inflation to continue to fall,” said Peter Jolly, head of market research for the investment-banking unit of National Australia Bank Ltd. in Sydney, the nation’s largest lender. “That should provide some near-term support” for Treasuries.”

Ten-year Treasury yields will decline to 3.5 percent by the end of June, he said.

Fed Bank of Dallas President Richard Fisher said yesterday the U.S. slump will probably persist until next year as consumers remain cautious, while the outlook for inflation remains “meek.”

Consumer prices fell 0.7 percent in April from the year before, according to the Labor Department. After accounting for prices in the economy, 10-year notes offer a so-called real yield of 4.31 percent, the most in 12 years.

TIPs

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, was 1.81 percentage points, versus the five-year average of 2.23 percentage points.

Obama has increased the U.S. marketable debt to an unprecedented $6.36 trillion to fund bank bailouts, stimulus spending and the budget deficit. The government will have to sell a record $3.25 trillion of Treasuries in the fiscal year ending Sept. 30, according to Goldman Sachs Group Inc., one of the 16 primary dealers required to bid at Treasury debt auctions.

The sales are sating investor demand even as the Fed buys Treasuries, planning to purchase as much as $300 billion of the securities by October.

‘Lot of Money’

“The Treasury is issuing a lot of money,” said Bill Gross, co-chief investment officer of Pacific Investment Management Co. “The market is beginning to wonder who is going to be buying these bonds.”

Gross spoke yesterday in an interview with Bloomberg News at the Morningstar Inc. investment conference in Chicago. Pimco, based in Newport Beach, California, is the world’s largest bond fund manager.

Rising mortgage rates helped fuel this week’s Treasury sell-off.

Higher home-loan costs can increase the average lives of mortgage-backed securities because refinancings may decline. The result is that investors find their bond portfolios have longer durations than they anticipated. Money managers cut their durations, the measure of a portfolio’s sensitivity to changes in yield, back to their intended targets by selling Treasuries.

The average rate on a typical 30-year fixed mortgage rose to 5.27 percent as of yesterday from 4.85 percent in April, according to North Palm Beach, Florida-based Bankarte.com.

To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.

Last Updated: May 29, 2009 01:38 EDT