Aug. 27 (Bloomberg) -- Treasuries were little changed after stocks fell on speculation that the 52 percent rally in the Standard & Poor’s 500 Index since March isn’t justified renewed the refuge appeal of U.S. government securities.

Bonds pared losses initially posted following a report that showed the U.S. economy contracted less than forecast by analysts from April through June. The government will sell a record-tying $28 billion of seven-year notes today.

“The bond market is still being driven by equities,” said Ajay Rajadhyaksha, head of U.S. fixed-income strategy in New York at Barclays Plc, one of the 18 primary dealers that are required to bid at Treasury auctions. “There is still an air of skepticism in the market if the economic recovery is indeed real, but every time a stronger number comes out that skepticism takes another hit.”

The 10-year note yield was little changed at 3.44 percent at 12:06 p.m. in New York, according to BGCantor Market Data. The 3.625 percent security maturing in August 2019 fell 1/32, or 31 cents per $1,000 face amount, to 101 18/32. Yields had climbed as high as 3.507 percent today.

In pre-auction trading, the seven-year notes yielded 3.109 percent, compared with a yield of 3.07 percent on the existing notes maturing in July 2016.

The Standard & Poor’s 500 Index slipped 0.6 percent to 1,022. The stock index had rallied 52 percent since March.

Gross domestic product shrank at a 1 percent annual rate from April to June, unchanged from what was reported for the quarter last month, the Commerce Department said. Analysts in a Bloomberg survey forecast a 1.5 percent drop.

Mortgage Purchases

A separate report today showed that fewer Americans filed claims for unemployment benefits last week, reinforcing evidence that the labor-market rout is easing. Initial jobless claims dropped to 570,000 from 580,000 the previous week, the Labor Department said.

Richmond President Jeffrey Lacker also said the central bank may not need to buy all of the mortgage-backed securities it has authorized by year-end as the economy shows signs of recovery. The Fed has said it would purchase as much as $1.25 trillion of mortgages securities to keep borrowing costs low.

“With the economy leveling out and beginning to grow again later this year, and with bank reserve demand ebbing as financial conditions improve, I will be evaluating carefully whether we need or want the additional stimulus that purchasing the full amount authorized under our agency mortgage-backed securities purchase program would provide,” Lacker said today during a speech in Danville, Virginia.

‘Off The Table’

The difference between yields on Washington-based Fannie Mae’s current-coupon 30-year fixed-rate mortgage securities and 10-year Treasuries narrowed 0.02 percentage point to 1 percentage point, Bloomberg data show.

“This is the first serious time we’ve heard from anyone at the Fed that we might need to raise rates or take some of the extraordinary efforts of quantitative easing off of the table,” said Guy Lebas, chief economist and fixed-income strategist with Janney Montgomery Scott LLC in Philadelphia. “This is not an official reversal, but the first signs of what could grow into a broader trend down the road, and so the market will pay attention.”

Fed policy makers said Aug. 12 that they would wind down a plan to purchase as much as $300 billion on Treasuries in a program that began in March. The central bank has bought $270.8 billion in Treasuries so far.

Today’s seven-year note auction follows two- and five-year sales this week. The auctions will total $109 billion, matching a record for these maturities.

Record Auctions

The seven-year notes scheduled for sale today yielded 3.09 percent in pre-auction trading, declining from 3.369 percent at the last auction of the securities on July 30. The sale drew bids for 2.63 times the amount of debt on offer, versus an average of 2.5 for the past five auctions.

““The market is trying to build in a concession to take down the supply,” said Martin Mitchell, head of government-bond trading in Baltimore for Stifel Nicolaus & Co.

Demand for the relative safety of government debt helped Treasuries return 0.7 percent in August, on top of a 0.4 percent gain in July, based on Merrill Lynch & Co.’s U.S. Treasury Master index. They are still down 3.5 percent this year.

German government bonds returned 0.4 percent this month, while Japanese debt gained 0.6 percent.

Yields indicate traders are cutting bets on inflation.

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, which reflects the outlook among traders for consumer prices, narrowed to 1.76 percentage points from 1.82 at the start of the week. The spread has averaged 2.20 percentage points for the past five years.

To contact the reporters on this story: Cordell Eddings in New York at Ceddings@bloomberg.net; Susanne Walker in New York at swalker33@bloomberg.net

Last Updated: August 27, 2009 12:11 EDT