Oct. 9 (Bloomberg) -- Treasuries fell, with two-year notes recording their first weekly loss since September, as Federal Reserve Chairman Ben S. Bernanke said the bank is ready to tighten monetary policy once the economic outlook improves.

Thirty-year bonds declined the most in four months after yesterday’s $12 billion auction of 30-year bonds, the last of four offerings this week totaling $78 billion, drew weaker-than- average demand. The yield on the 30-year bond closed below 4 percent last week for the first time since April as reports showed manufacturing declined and inflation remains subdued.

“The Bernanke statements were more of the same, that rates will be low for a long time, but what the market took away today is that when they do begin raising rates, they will have to do so aggressively,” said Larry Milstein, managing director of government and agency debt trading at RW Pressprich & Co., a fixed-income broker and dealer in New York for institutional investors.

The yield on the two-year note rose eight basis points, or 0.08 percentage point, to 0.97 percent at 4:19 p.m. in New York, according BGCantor Market Data. The 1 percent security maturing in September 2011 fell 5/32, or $1.56 per $1,000 face amount, to 100 2/32. Yields have climbed 10 basis points since Oct. 2, the first weekly increase since Sept. 18.

Yields on 30-year bonds rose 14 basis points to 4.22 percent. The yield increased as much as 16 basis points, the most since it gained 18 basis points on June 10. For the week the yield has increased 23 basis points, the most since it rose 31 basis points the week ended Aug. 7.

‘Prepared to Tighten’

“We see somewhat of a reversal on the long bond,” said Christopher Sullivan, who oversees $1.4 billion as chief investment officer at United Nations Federal Credit Union in New York. “The long end may have come too far too fast, but with inflation expected to stay pretty low the long end shouldn’t sell off too much from here.”

The Federal Open Market Committee reiterated its pledge last month to keep the benchmark lending rate at around zero “for an extended period” to boost a weak recovery that has yet to create jobs.

“As economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road,” Bernanke said yesterday at a Board of Governors conference on monetary economics in Washington. “When the economic outlook has improved sufficiently, we will be prepared to tighten.”

Notion Rejected

The Fed will hold off raising interest rates until the third quarter of 2010 as the recovery is likely to be too weak to lift employment and incomes, according to a September survey of 57 economists by Bloomberg News. Futures on the Chicago Board of Trade show a 40.5 percent chance the central bank will boost borrowing costs from the current range of zero to 0.25 percent by March.

The 10-year yield could fall as low as 3.1 percent “as stalling economic improvements have outweighed auction supply,” wrote analysts led by New York-based Brett Rose at Citigroup Inc. in a note to clients. The high end of their range is 3.7 percent, according to the note. The 10-year note yield touched 3.1 percent on Oct. 2, the lowest level since May.

The Fed is considering accessing money market funds through clearing banks or creating a facility to drain the record amount of cash added to the financial system, according to people familiar with the plans.

Those methods may help conserve the capital of the 18 primary dealers that act as counterparties for open market transactions as the Fed removes some of the more than $1 trillion the central bank pumped the economy, said the people, who declined to be identified because no decision has been made.

White House economic adviser Lawrence Summers rejected the notion that the U.S. faces an extended period of below-average growth and high unemployment in the wake of the worst recession since the 1930s.

Bid-to-Cover

“I would be very reluctant to accept the idea that the American economy no longer has the potential to grow rapidly,” Summers told a forum in New York yesterday organized by Bloomberg LP, the parent of Bloomberg News. “The American people have not become less capable of entrepreneurship. They have not become less dedicated to hard work, and the productive potential of this economy has not declined.”

The bid-to-cover ratio at the 30-year sale yesterday, which gauges demand by comparing total bids with the amount of securities offered, was 2.37, compared with 2.92 at the September auction and an average of 2.42 for the past 10 sales.

“The short end of the Treasury curve has the most to lose on a relative basis,” wrote William O’Donnell, U.S. government bond strategist in Stamford, Connecticut, at primary dealer RBS Securities Inc., in a note to clients. Investors “continue to push out the curve and the flow-trends still clearly favor further flattening in the curve,” he said.

The difference in yield, or spread, between 30-year notes and similar-maturity Treasury Inflation Protected Securities, which reflects the outlook among traders for consumer prices, has widened to 2.11 percentage points from 1.96 percentage points a week ago.

To contact the reporter on this story: Cordell Eddings in New York at ceddings@bloomberg.net.

Last Updated: October 9, 2009 16:29 EDT