April 13 (Bloomberg) -- Treasuries rose after the Federal Reserve completed the first of three buybacks of government debt slated for this week in an effort to lower borrowing costs and revive the world’s largest economy.

Yields on 10-year notes fell the most since March 18, when policy makers announced the $300 billion program, as the central bank bought $7.37 billion in two- and three-year securities. The Fed has acquired $43.9 billion of Treasuries since beginning the purchases on March 25.

“The U.S. government is the 800-pound gorilla in the bond market,” Andrew Brenner, co-head of structured products and emerging markets in New York at MF Global Inc., the world’s largest broker of exchange-traded futures and options contracts, wrote in a note to clients. “Bond markets acted in accordance with the liquidity provided and traded up.”

The yield on the 10-year note fell seven basis points, or 0.07 percentage point, to 2.86 percent at 4:47 p.m. in New York, according to BGCantor Market Data. The price of the 2.75 percent security due February 2019 rose 18/32, or $5.63 per $1,000 face amount, to 99 2/32.

Ten-year yields have traded in a range between 2.45 percent and 3.05 percent since late January as concerns about record Treasury supply were offset by the Fed’s purchase program.

$2.09 Trillion

If 10-year yields rise above 3.05 percent, “the Fed will step up its purchase operations, so we look for good support below the market,” said Martin Mitchell, head of government bond trading at the Baltimore unit of Stifel Nicolaus & Co. “On the other hand, the price action will continue to struggle under the weight of the supply.”

The U.S. needs to borrow $3.25 trillion this fiscal year, according to Goldman Sachs Group Inc. President Barack Obama is asking Congress to approve a $3.55 trillion budget for 2010. The nonpartisan Congressional Budget Office estimated the deficit at $1.38 trillion, higher than the White House’s $1.17 trillion projection.

The Treasury will next sell securities at an auction of five-year inflation-indexed notes on April 23. Sales of nominal Treasuries will resume on April 27 with an auction of two-year notes. The government will sell five- and seven-year notes on April 28 and April 29, respectively.

The Fed will buy U.S. debt due from September 2013 to February 2016 tomorrow and due from January 2010 to April 2032 on April 16, according to its Web site, part of its plan to buy as much as $300 billion over six months. It has more than doubled the size of its balance sheet to $2.09 trillion in the past year through the purchase of financial assets.

Not That Successful

The central bank will reach its $300 billion target in “less than four months,” said Michael Cloherty, head of U.S. interest rate research at Bank of America-Merrill Lynch in New York. Even so, the program has not been that successful, Cloherty said.

“It hasn’t driven down yields that much,” Cloherty said in an interview today on Bloomberg Radio. “Government purchases are not a net addition to total demand.”

The 10-year yield is about 15 basis points from the 3.01 percent level seen on March 18, when the Fed announced the program. The yield fell 47 basis points that day, the most since 1962, to 2.54 percent.

Fed Chairman Ben S. Bernanke’s programs may result in a higher cost of living, said Allan Meltzer, the central bank historian and professor of political economy at Carnegie Mellon University in Pittsburgh. Rising costs erode the value of the fixed payments from bonds.

Inflation ‘Higher’

Inflation “will get higher than it was in the 1970s,” Meltzer said. At the end of that decade, consumer prices rose at a year-over-year rate of 13.3 percent.

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, which reflects the outlook among traders for consumer prices, fell two basis points from Friday’s level to 1.33 percentage points, up from near zero at the end of 2008. The average for the past five years is 2.25 percentage points.

The U.S. consumer price index probably fell 0.1 percent in March from a year earlier, according to economists surveyed by Bloomberg before the Labor Department report on April 15.

U.S. retail sales probably rose 0.3 percent in March, the second gain in the last three months, according to the median estimate in a Bloomberg survey before the Commerce Department report tomorrow.

Pimco Holdings

Government securities have fallen 1.2 percent in April, extending a 1.4 percent loss in the first quarter that’s the worst yearly start since 1999, according to Merrill Lynch & Co.’s U.S. Treasury Master Index.

Bill Gross, manager of Pacific Investment Management Co.’s $144 billion Total Return Fund, increased his holdings of U.S. government debt to 28 percent in March, the highest percentage in almost two years, according to the Newport Beach, California- based company’s Web site. In January, Gross held a negative position in government debt securities such as Treasuries, agency debt or interest-rate derivatives.

China, the largest foreign holder of U.S. debt, should buy more short-maturity U.S. Treasuries than long-term notes, the Oriental Morning Post reported today, citing a former adviser to the People’s Bank of China.

TED Spread

The government should “adjust the maturity structure, and keep asset and currency structures basically unchanged,” Li Yang said in Beijing, the Chinese-language newspaper reported.

Foreign holdings of Treasury bills surged to a record $486.9 billion in January from $207.1 billion a year earlier, according to the Treasury Department.

The difference between two- and 10-year yields widened to 1.97 percentage points from 1.25 percentage points in December as investors demanded higher yields to lend to the government for longer periods.

Yields indicate a recovery in the debt markets, though trading hasn’t recovered to where it was before the credit crunch began in 2007. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, narrowed to 96 basis points from 2008’s high of 4.64 percentage points in October. The figure was about 33 basis points two years ago.

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

Last Updated: April 13, 2009 17:00 EDT