Oct. 31 (Bloomberg) -- Treasuries fell for the week, with 10-year notes headed for their worst five days since June, amid speculation the government's efforts to unfreeze credit markets are beginning to work, easing demand for U.S. securities.

The London interbank offered rate, or Libor, that banks charge each other for three-month dollar loans dropped 49 basis points on the week to its lowest in six weeks, according to the British Bankers' Association. Sales of short-term corporate IOUs rose to a record. The Federal Reserve cut the benchmark interest rate to 1 percent.

``The theme for the week has been, and will be for the next couple of weeks, the meaningful improvement in Libor,'' said Michael Cloherty, head of Treasury and agency strategy at Banc of America Securities LLC, one of 17 primary dealers that trade with the central bank. ``Some of the Fed programs are having a meaningful impact, reversing some of the flight to quality.''

The yield on the 10-year note climbed 27 basis points, or 0.27 percentage point, to 3.94 percent at 2:21 p.m. in New York, according to BGCantor Market Data. It was the biggest weekly increase since the period ended June 13. The yield was little changed for the day. The 4 percent security maturing in August 2018 dropped 2 8/32 for the week, or $22.50 per $1,000 face amount, to 100 14/32.

Two-year note yields gained 4 basis points on the week to 1.55 percent.

Treasuries lost 0.91 percent this week through yesterday, according to Merrill Lynch & Co.'s Treasury Master index.

Core Price Gauge

U.S. securities today pared early gains after a government report showed consumer spending slowed, adding to speculation the economy will continue to deteriorate.

The drop in purchases by U.S. consumers followed no change in August and July, the Commerce Department said in Washington. Economists had forecast spending would fall 0.2 percent, according to the median of 73 projections in a Bloomberg News survey.

The central bank cut its target rate for overnight bank lending by half a percentage point Oct. 29 to 1 percent, the lowest level since June 2004, saying ``downside'' risks to growth remain. The economy declined in the third quarter the most since 2001, a Commerce Department report showed yesterday.

Futures on the Chicago Board of Trade show a 66 percent probability the Fed will reduce its target rate to 0.5 percent at its Dec. 16 meeting. The odds a week ago were zero. The rest of the bets are for a quarter-percentage point reduction.

Traders have questioned the futures market's ability to predict interest rates, because what banks charge each other for overnight loans has not followed the Fed's target rate. This suggests traders may not be able to accurately gauge the Fed's policy response.

`Still on Tenterhooks'

``The economy is still on tenterhooks,'' said Paul Horrmann, a strategist in Jersey City, New Jersey, at ICAP Plc, the world's largest inter-dealer broker. ``People will put money into the front end in a more protectionary stance. People still want protection until liquidity comes back -- and that will only come back when confidence returns.''

Fed Chairman Ben S. Bernanke said the mortgage-backed bonds market will need some form of government support through either guarantees or insurance programs to weather times of heightened stress. In remarks for a Berkeley, California, conference, he also said mortgage companies Fannie Mae and Freddie Mac should retain some form of government support and oversight.

Yields indicate banks are more willing to lend than they were three weeks ago. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, narrowed to 2.59 percentage points from a high of 4.64 percentage points Oct. 10.

Libor Falls

Banks' cost of borrowing dollars overnight fell to a record low. The Libor that banks charge each other for overnight loans in dollars tumbled 88 basis points on the week to 0.41 percent. Three-month Libor dropped to 3.03 percent, from 3.52 percent a week ago.

Corporate borrowing in the U.S. commercial paper market soared the most on record after the Fed began buying the debt directly from issuers this week. The amount of short-term corporate IOUs outstanding rose by $100.5 billion, or 6.9 percent, to a seasonally adjusted $1.55 trillion for the week ended Oct. 29, according to Fed data.

The difference in yield, or spread, between two- and 10- year securities was 2.38 percentage points, near the most since 2004. It was 2.17 points a week ago. The so-called yield curve has steepened as longer-term securities lagged behind in anticipation of increased government debt auctions.

Borrowing Needs

``A lot of the conservative money is still on the sidelines and suffering much lower yields in the Treasury market,'' said William Larkin, a portfolio manager at Cabot Money Management in Salem, Massachusetts, which manages about $500 million in assets. ``Three-month bills are alarmingly low.''

Rates on three-month Treasury bills have shed 41 basis points this week to 0.44 percent.

U.S. borrowing needs will almost double this fiscal year to $2 trillion, Goldman Sachs Group Inc. forecast. The government auctioned off $64 billion in two- and five-year notes and five- year Treasury Inflation Protected Securities this week.

The two-year note auction drew a yield of 1.60 percent, the lowest since March 2004. Demand was stronger than the average at the last 10 auctions, judged by the bid-to-cover ratio, which compares the number of bids with the amount of securities held. The ratio was 2.49, compared with a 10-sale average of 2.31.

The Treasury is scheduled to announce Nov. 5 how it will boost debt sales. It has said it will have a decision at that time on reviving the three-year note and holding more frequent 10- and 30-year securities sales.

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

Last Updated: October 31, 2008 14:30 EDT