Jan. 6 (Bloomberg) -- Treasuries were little changed after President-elect Barack Obama said the U.S. will soon face budget deficits near $1 trillion, raising concern that a record level of securities will be needed to finance the shortfalls.

The Treasury’s sale of $8 billion in inflation-indexed notes at auction today drew the most demand in nine years, suggesting investors are concerned that inflation may accelerate along with government spending.

“If anything, the auction showed demand for inflation protection, which is ultimately bearish for the Treasury market,” said Ian Lyngen, an interest-rate strategist in Greenwich, Connecticut, a Greenwich Capital, one of 17 primary dealers that are required to bid at government debt auctions.

The two-year note yielded 0.77 percent at 5:12 p.m. in New York, according to BGCantor Market Data. The price of the 0.875 percent security due in December 2010 traded at 100 6/32. The five-year note yielded 1.65 percent.

The auction of Treasury Inflation Protected Securities, or TIPS, drew a yield of 2.245 percent. The so-called bid-to-cover ratio, a gauge of demand, was 2.48, the highest since Jan. 12, 2000, when it was 3.07. The amount of notes sold on a non- competitive basis, mainly to individual investors, was the highest since at least 2003.

This week’s debt sales also include a record $30 billion of three-year notes tomorrow and $16 billion of 10-year conventional debt the next day.

30-Year Bond

“People do anticipate more supply going forward; that’s not new, but it’s here,” said Tom Tucci, head of U.S. government bond trading in New York at RBC Capital Markets, the investment- banking arm of Canada’s biggest lender. “We are trying to settle back into a range where people can determine value.”

Thirty-year bonds rose late today as companies selling corporate debt removed so-called rate lock agreements, in which they bet on Treasury prices falling to guard against the effect higher yields would have on the planned debt sale. Once the debt is sold, they end the agreements and buy back Treasuries.

“People have been short and are now making some money back in Treasuries,” said Carl Lantz, an interest-rate strategist in New York at Credit Suisse Securities USA LLC, another primary dealer. “We just refer to it as an unwind of rate lock hedges.” So-called short positions are bets that Treasury prices will fall.

Anheuser-Busch InBev NV, the world’s largest brewer, and Brazil led 11 issuers offering at least $18.5 billion of dollar- denominated bonds today.

‘Years to Come’

Obama said that a “trillion-dollar deficit will be here before we even start the next budget.” Similar shortfalls are in store “for years to come,” he said after meeting in Washington today with his economic advisers.

Federal Reserve officials saw “substantial” risks to the slumping economy last month as they cut the benchmark interest rate to a range of zero to 0.25 percent and pledged to expand emergency loans if necessary, according to the minutes of the Dec. 15-16 Federal Open Market Committee meeting released in Washington. Some officials saw “the distinct possibility of a prolonged contraction” stemming partly from stresses in financial markets.

Investors and companies snapped up Treasuries in December amid concern the credit crisis, which has generated $1 trillion in losses, would lead to a cash crunch at year-end. Ten-year Treasuries are becoming “bubble like,” and the risk of an “unruly unwind of long positions” will increase as the first quarter progresses, Barclays Plc strategists including Jordan Kotick in New York said in a note yesterday.

Higher-Yielding Assets

This month, investors and traders have bought higher- yielding assets and sold government debt. Company debt yielded 5.96 percentage points more than benchmark Treasuries yesterday, down from 6.04 percentage points Dec. 31, according to Merrill Lynch & Co.’s Corporate Master Index.

The Federal Reserve Bank of New York started buying mortgage-backed securities yesterday as part of a $500 billion program to support the U.S. housing market.

Fed officials are focused on driving down the spreads between Treasury yields and consumer and corporate loans, in a bid to further ease the lending squeeze. Fifteen-year fixed-rate mortgages were 5.06 percent last week, 2.59 percentage points above 10-year Treasury yields; the spread averaged 0.88 point in 2003, when the central bank slashed rates to 1 percent.

‘Unfreezing of Credit’

Yields suggest banks are becoming more willing to lend. The difference between what banks and the Treasury pay to borrow for three months, the so-called TED spread, narrowed to 1.28 percentage points, down from a peak of 4.64 percentage points in October and the least since Sept. 11.

“We’re seeing an unfreezing of credit,” said Jay Mueller, who manages about $3 billion of bonds at Wells Fargo Capital Management in Milwaukee. “The incredible rally we had on the Treasury side, which was virtually all panic-driven, is being partly reversed.”

Payrolls fell 500,000 in December, bringing last year’s job losses to 2.4 million, the most since 1945, according to the median estimate of 69 economists surveyed by Bloomberg News. The data is due Jan. 9 from the Department of Labor.

The Institute for Supply Management’s index of non- manufacturing businesses, which make up almost 90 percent of the economy, rose to 40.6 in December from a record-low 37.3 the prior month, the Tempe, Arizona-based ISM said today. Readings below 50 signal contraction. The median forecast in a Bloomberg News survey of economists was for a drop to 36.5.

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

Last Updated: January 6, 2009 17:24 EST