Feb. 6 (Bloomberg) -- U.S. Treasuries rose for a sixth day, led by two-year notes, as Asian and European stocks declined, fueling demand for the relative safety of government debt.

Investors are stepping up bets the Federal Reserve will cut interest rates by as much as 75 basis points next month to stave off a recession, pushing two-year yields to within 7 basis points of a 3 1/2-year low. The yield difference between German and U.S. two-year notes was 9 basis points short of the widest since 2002 on speculation the European Central Bank will leave its key rate unchanged tomorrow.

``The Fed's aggressive cutting isn't over,'' said Wee-Ming Ting, who helps invest the equivalent of $125.9 billion at Pictet Asset Management in Singapore. ``We still have room'' for short-term yields to fall.

The two-year yield fell 1 basis point to 1.90 percent as of 9:39 a.m. in London, according to bond broker Cantor Fitzgerald LP. It was at 1.88 percent earlier. The yield dropped to 1.84 percent on Jan. 23, the lowest level since April 2004.

The price of the 2 1/8 percent security due January 2010 rose 1/32, or 31 cents per $1,000 face amount, to 100 14/32. A basis point is 0.01 percentage point. Two-year rates will drop to 1.5 percent within a month, Ting forecast.

Gains in 10-year notes were limited before an auction of $13 billion of the securities today, with the yield little changed at 3.56 percent. Investors bid for 2.23 times the amount of debt on offer at the last 10-year sale on Dec. 13. The average for the past 10 auctions is 2.44.

Inverse to Stocks

The Treasury is also scheduled to sell $9 billion of 30- year bonds tomorrow. Thirty-year yields fell to 4.10 percent on Jan. 23, the lowest since regular sales of the debt began in 1977. They were little changed at 4.32 percent today.

Treasuries are moving inversely to stocks, with traders taking the direction of equities as a barometer of investor appetite for higher-yielding assets. Stocks declined worldwide after U.S. equities tumbled the most in 11 months yesterday. The MSCI World Index lost 0.8 percent today, its third consecutive decline.

Two-year yields have a correlation of 0.84 with the MSCI index this year, with a reading of 1 indicating they move in lockstep, according to data compiled by Bloomberg.

Pictet Asset, part of Switzerland's largest closely held private bank, holds positions that will benefit if two-year yields fall and 10-year yields rise, Ting said.

Two-year Treasuries yielded 1.66 percentage points less than their 10-year counterparts today, the most since 2004. Shorter-maturity notes are more sensitive to changes in monetary policy, while securities of 10 years or longer are influenced by inflation.

TED Spread

Treasuries rallied yesterday after a report from the Institute for Supply Management showed U.S. service industries unexpectedly contracted in January at the fastest pace since the 2001 recession.

The difference between what banks and the U.S. government pay for three-month loans signals a shortage of credit in money markets may increase. The so-called TED spread widened to 97 basis points today, compared with 92 basis points at the start of the week. It was as high as 221 basis points in December.

Traders are assigning 26 percent odds to the chance the Fed will trim its benchmark rate by 75 basis points to 2.25 percent by its March 18 meeting, futures on the Chicago Board of Trade show. The odds increased from 14 percent yesterday. The rest of the bets are for a half-point cut.

Fed Chairman Ben S. Bernanke has already reduced the target for overnight loans between banks by 1.25 percentage points this year.

Breakeven Rate

Inflation expectations are falling, judging by market levels. Ten-year notes yielded 2.25 percentage points more than similar-maturity Treasury Inflation Protected Securities, narrowing from 2.38 points a week ago. The difference reflects the rate of inflation that traders expect for the next decade.

``The downside potential in yields seems limited,'' said Shinji Kunibe, who helps oversee $847 billion globally at the Tokyo branch of JPMorgan Asset Management, part of the third- biggest U.S. bank. ``The auctions might not go well.''

Kunibe said he's favoring five-year European government bonds. German debt due in January 2013 yielded 3.42 percent, or 83 basis points more than their U.S. counterparts, according to Bloomberg data. The spread may narrow 30 basis points by the middle of 2008, he said. There was no difference as recently as October.

Treasuries returned 3 percent this year, according to an index compiled by Merrill Lynch & Co. The S&P 500 handed investors an 8.8 percent loss including reinvested dividends, as declines stemming from defaulted subprime mortgages threatened to throw the U.S. economy into a recession.

``There is an equity-bond nexus that is driving markets,'' said Damien McColough, chief debt strategist at Westpac Banking Corp. in Sydney, Australia's fourth-largest lender. ``I can wake up in the morning and know that Treasuries are up by seeing that stocks are down.'' The yield on two-year Treasuries will decline to 1.8 percent in the next month, McColough said.

To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net; Agnes Lovasz in London at alovasz@bloomberg.net

Last Updated: February 6, 2008 05:05 EST