Nov. 8 (Bloomberg) -- Treasuries rose for the week, with two-year notes gaining the most in a month, as signs of economic weakness mounted and traders boosted bets the Federal Reserve will cut interest rates below 1 percent to revive growth.

Government debt advanced amid concern U.S. growth will shrink further. Reports showed manufacturing contracted in October at the fastest pace since 1982 and service industries declined for the sixth time in 10 months. The unemployment rate rose to a 14-year high as the economy shed 524,000 jobs over the past two months.

``We're probably going to see additional down numbers going forward -- it's too hard to call a bottom,'' said Sean Simko, who oversees $8 billion at SEI Investments Co. in Oaks, Pennsylvania. ``It still has more room for yields to move lower. I'd expect the curve to steepen here, and the front end, the two-year and the five-year, to move lower.''

The two-year note's yield dropped 23 basis points this week, or 0.23 percentage point, to 1.33 percent, according to BGCantor Market data. It touched 1.24 percent on Nov. 6, the lowest since March 17. The 1.5 percent security due in October 2010 rose 14/32, or $4.38 per $1,000 face amount, to 100 11/32.

Ten-year note yields fell 18 basis points on the week to 3.79 percent. Yields on 30-year bonds decreased 9 basis points to 4.27 percent.

Yield Curve

Two-year notes, more sensitive to monetary policy, yielded 2.48 percentage points less than 10-year notes, close to the biggest difference since 2004. The size of the gap signaled investors are pessimistic about the economic outlook. The so- called yield curve may steepen to as much as 3 percentage points, according to Credit Suisse Group AG analysts.

Yields on two-year notes have been 23 basis points higher than the federal-funds target on average this decade. They'll end the year at 1.43 percent, according to the weighted average of forecasts in a Bloomberg survey. Ten-year notes will yield 3.59 percent at year-end, another Bloomberg survey showed.

The U.S. unemployment rate climbed to 6.5 percent in October from 6.1 percent the previous month, the Labor Department reported yesterday. Employers eliminated 240,000 jobs after doing away with 284,000 in September.

Earlier in the week, the Institute for Supply Management's non-manufacturing index, which covers almost 90 percent of the economy, dropped to 44.4 for October, the lowest since records began in 1997, from 50.2 the previous month. The Tempe, Arizona- based group's factory index fell to 38.9, a 26-year low. Readings of 50 are the dividing line between growth and contraction.

`In Trouble'

``The problem now is that the consumer has just completely pulled back,'' said William Larkin, a portfolio manager at Cabot Money Management in Salem, Massachusetts, which manages about $500 million in assets. ``Any consumer-led business will be in trouble until that psychology turns around. People forget that monetary policy is effective; it just takes time.''

Traders increased bets the weak economy will lead the Fed to cut the 1 percent target rate for interbank lending at its next meeting, on Dec. 16. Odds yesterday were 99 percent, compared with 55 percent a week earlier, that policy makers will lower the rate to 0.5 percent. The rest of the bets were for a reduction to 0.25 percent.

The Treasury plans to sell $25 billion in three-year notes on Nov. 10, $20 billion in 10-year notes Nov. 12 and $10 billion in 30-year bonds Nov. 13. U.S. borrowing needs are expected to rise to a record $550 billion in the three months to Dec. 31, the department said Nov. 3.

`Weak Growth'

``From a tactical perspective, the market needs to be cheapened up to take down the supply next week,'' said Robert Tipp, chief investment strategist for fixed income in Newark, New Jersey, at Prudential Investment Management. Still, ``once you get through the refunding, the market represents pretty good value,'' given ``the prospect of weak growth.''

President-elect Barack Obama vowed today that ``immediately after'' taking office he will confront the faltering economy. There's no doubt a recession is under way, said the Stanford University economist who leads the committee that dates economic cycles. ``The evidence is more than compelling,'' Robert Hall, who heads the National Bureau of Economic Research panel, said in an interview. The group is waiting to determine the exact start date.

Goldman Sachs Group Inc. forecast the deepest U.S. recession since 1982, with the economy shrinking 3.5 percent in the fourth quarter and 2 percent in the first quarter.

General Motors Corp., which is seeking federal aid to avoid collapse, said it may not have enough cash to keep operating this year.

Treasury Probe

The Treasury yesterday began reviewing the trading of two- and five-year notes after a scarcity in U.S. government securities triggered by the credit crunch led to a record level of failed transactions. Failures in the repurchase-agreement, or repo, market for borrowing and lending securities rose last month to a record $5.311 trillion, the most since 1990.

The probe aims to identify any improper trading by investors in the 2 percent two-year note due Sept. 30, 2010, and the 3 1/8 percent five-year note due Sept. 30, 2013.

To contact the reporters on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net; Sandra Hernandez in New York at shernandez4@bloomberg.net.

Last Updated: November 8, 2008 08:00 EST