Dec. 12 (Bloomberg) -- Japanese government bonds rose after global stocks tumbled on speculation yesterday's Federal Reserve interest-rate cut was too small to prevent a U.S. recession.

Benchmark 10-year debt completed the biggest rally in more than a month as traders increased bets that a slowdown in the world's largest economy will prevent the Bank of Japan from raising interest rates during the first half of 2008. Treasuries gained the most in more than three years yesterday, while U.S. stocks completed the biggest slide in a month.

``The flight-to-quality bid comes back to bonds,'' said John Richards, head of debt strategy for the Asia-Pacific region at RBS Securities Japan Ltd., one of the 26 primary dealers that are required to bid at auctions, in Tokyo. ``Yields plummeted in the U.S. and the same thing is happening in Japan.''

The yield on the benchmark 10-year bond due December 2017 declined 6.5 basis points to 1.515 percent at 5:12 p.m. in Tokyo, the biggest drop since Nov. 2. The price added 0.560 yen to 99.869. A basis point is 0.01 percentage point.

Ten-year bond futures for March delivery gained 0.71 to 136.65 as of the afternoon close in Tokyo. The Nikkei 225 Stock Average slid 0.7 percent.

The Fed lowered its benchmark rate a quarter point to 4.25 percent, defying some predictions of a half-point cut. The Dow Jones Industrial Average declined 2.1 percent and the Standard & Poor's 500 Index lost 2.5 percent.

Fed Disappoints

``A lot of market participants feel that the Fed is not particularly cohesive and they cannot understand why the Fed hasn't done anything on the liquidity front,'' Richards said.

The gap between three-month bill yields and the London interbank offered rate, or Libor, was at the widest in three months, signaling that banks are reluctant to lend to each other.

The so-called TED spread expanded to 2.21 percentage points, the widest since Aug. 20, when funds dumped assets linked to a collapsing U.S. mortgage market in favor of the short-term government debt. The difference has more than doubled this month.

Three-month euroyen futures contracts for September 2008 delivery fell half a basis point to 0.84 percent, compared with 1.42 percent on July 13, the highest this year. The contracts are settled at Tibor, the Tokyo interbank offered rate.

``Euroyen futures are used to bet on monetary policy,'' said Ngoc Le Nhan, a debt analyst at ABN Amro Securities Japan Ltd. in Tokyo. ``The decline in yield level implied by these contracts clearly reflects that rate hike expectations are being pushed back.''

Expensive Two-Year Notes

Two-year bonds are ``expensive'' because their yields are below three-month Tibor, Nhan said.

The yield on the 0.8 percent bond due December 2009 fell 2.5 basis points to 0.71 percent. It earlier declined to as low as 0.695 percent, the least since February 1. The price of the securities rose 0.050 yen to 100.177 yen.

Three-month Tibor was about 14.8 basis points above two- year yields, the highest premium since February 2001.

Government bond yields in Japan have fallen from highs in June as investors globally bought government debt as concern spread of a global slowdown in economic growth. Ten-year yields have dropped almost half a percentage point since June 13, while two-year yields have declined 40.5 basis points.

Japan's economy is headed for a ``mild recession'' that could be worsened should a bigger-than-expected U.S. slowdown halt the nation's export-led expansion, said Takehiro Sato, chief Japan economist at Morgan Stanley.

Default Swaps

Demand for Japan's debt also increased on speculation the rising risk of companies defaulting on debt will prompt investors to switch to the fixed payment of bonds.

Credit-default swaps on the Markit iTraxx Japan index rose half a basis point to 42 basis points, according to Morgan Stanley prices. The benchmark, which contains credit-default swaps tied to 50 investment-grade Japanese companies, rises as perceptions of credit quality deteriorate.

Bonds also gained after the Nikkei Financial Daily reported Japan's bond sales may total 107 trillion yen ($966 billion) next fiscal year, 2 trillion yen less than this year. The newspaper cited a survey of bond traders.

To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net.

Last Updated: December 12, 2007 03:15 EST