May 28 (Bloomberg) -- Treasuries gained for the first time in five days as foreclosures surged to the most on record and the highest yields since November attracted investors.

Yields on 10-year Treasuries rose almost half a percentage point since May 21 amid growing concern that international investors will shy away from buying U.S. debt. The U.S. auctioned $26 billion in seven-year securites, the last of three note sales this week totaling a record-tying $101 billion.

“Prices are recovering a bit,” said Nils Overdahl, a bond-fund manager at New Century in Bethesda, Maryland, which oversees $500 million. “We are still in a difficult economic environment.”

Ten-year note yields fell 11 basis points, or 0.11 percentage point, to 3.62 percent at 5:01 p.m. in New York, according to BGCantor Market Data. The notes dropped the most last week since June 2008, pushing yields up 31 basis points, as investors speculated a record supply of Treasuries to pay for a mounting budget deficit may jeopardize the U.S.’s AAA credit rating.

Thirty-year bond yields fell 18 basis points to 4.49 percent. It yesterday touched 4.65 percent, the highest level in almost ten months.

Indirect Bids

More than $300 billion of Treasuries changed hands for the second straight day, the only times since Oct. 16 that Treasury volume has crossed the $300 billion threshold, according to Icap Plc, the world’s largest interdealer broker. More than $303 billion were traded today while $371 billion were exchanged yesterday.

Today’s auction drew a yield of 3.30 percent, compared with the average forecast of 3.263 percent in a Bloomberg News survey of nine bond-trading firms.

The ratio of total bids to the amount on offer, known as the bid-to-cover, was 2.26, compared with an average of 2.3 at the three auctions since the note was reintroduced in February.

Indirect bidders, the class of investors that includes foreign central banks, bought 33 percent of the notes sold. They purchased an average of 33.2 percent of the notes in the past three seven-year auctions.

“It wasn’t a stellar auction, but it was a good one,” said William Larkin, a fixed-income portfolio manager in Salem, Massachusetts at Cabot Money Management, which manages $500 million.

Mortgage Delinquencies

The U.S. mortgage delinquency rate climbed to a seasonally adjusted 9.12 percent and the share of loans entering foreclosure rose to 1.37 percent, the Mortgage Bankers Association said today. Both figures are the highest in records going back to 1972.

Sales of new homes increased 0.3 percent to an annual pace of 352,000, lower than forecast, after a 351,000 rate in March, the Commerce Department said today in Washington.

Yields on 10-year notes fell to within 2.65 percentage points of those on two-year notes. The so-called yield curve reached a record high of 2.76 percentage points yesterday.

A steepening yield curve suggests investors are demanding more to lend to the government for longer terms because of the risk that an increased debt sales will lead to faster inflation or a possible downgrade to the U.S.’s credit rating.

“Some people are looking at the steepest levels in the yield curve and we’re starting to see some buying,” said Dan Orlando, head of U.S. government bond trading in New York at Deutsche Bank Securities Inc., one of 16 primary dealers required to bid at Treasury auctions.

Bond Vigilantes

“The Treasury is issuing a lot of money,” said Bill Gross, co-chief investment officer of Pacific Investment Management Co. “The market is beginning to wonder who is going to be buying these bonds.”

Gross spoke in an interview with Bloomberg News at the Morningstar Inc. investment conference in Chicago. Pimco, based in Newport Beach, California, is the world’s largest bond manager.

Treasuries have lost 5.1 percent this year, according to Merrill Lynch & Co.’s U.S. Treasury Master Index, after last year’s 14 percent gain.

Investors in Treasuries are bedeviling President Barack Obama as he embarks on the most costly spending plan in U.S. history. So-called ‘bond vigilantes’ speculate that Obama’s record borrowing and spending plans will produce inflation, eroding the value of fixed-income securities.

The U.S. will sell $3.25 trillion of debt in the fiscal year ending Sept. 30, according to primary dealer Goldman Sachs Group Inc.

Obama has pushed the nation’s marketable debt to an unprecedented $6.36 trillion. His administration raised on May 11 its estimate for the deficit this year to a record $1.84 trillion, up 5 percent from the February estimate, and equal to about 13 percent of the nation’s GDP.

‘It’s Premature’

The term ‘bond vigilante’ was used to describe bearish traders who drove up long-term interest rates and persuaded President Bill Clinton to place deficit reduction above fulfilling his spending promises.

Fitch Ratings analyst David Riley said “it’s premature for the U.S. rating to be in play,” even as the government of the world’s largest economy ramps up debt sales. Riley, the London- based head of sovereign ratings at the company, spoke at a conference in New York.

Speculation increased that the U.S.’s top-credit rating may be under threat after Standard & Poor’s cut Britain’s outlook to “negative” from “stable” last week, citing the nation’s soaring debt burden. Moody’s Investors Service said yesterday the U.S. government’s Aaa credit rating is stable “even with a significant deterioration” in the nation’s debt burden.

The U.S.’s $11.2 trillion of debt is about 79 percent of the $14.1 trillion in gross domestic product, according to Bloomberg data. In the U.K., the debt-to-GDP ratio approaches 100 percent.

Mortgage Hedging

Rising Treasury yields are also pushing up yields on securities backed by home loans, threatening to undermine the government’s efforts to keep consumer borrowing costs low.

Mortgage bond yields are now higher than before the Federal Reserve announced March 18 it would expand purchases of those securities to stem the housing slump and bolster consumer spending. Yields on Washington-based Fannie Mae’s current-coupon 30-year fixed-rate mortgage bonds climbed to 4.69 percent yesterday, the highest since Dec. 5 and up from 3.94 percent on May 20, Bloomberg data show.

“The market expects the Fed to enhance buying of Treasuries very soon,” wrote David Ader, head of U.S. government bond strategy at Greenwich, Connecticut-based primary dealer RBS Greenwich Capital, in a note to clients. “The bear market in Treasuries is having an impact on other things. Mortgages were the most notable victim.”

The average rate on a 30-year mortgage increased eight basis points to 5.08 percent yesterday, according to Palm Beach, Florida-based Bankrate.com. That’s 141 basis points higher than the 10-year Treasury yield, compared with 305 basis points at the start of the year.

To contact the reporter on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net; Susanne Walker in New York at swalker33@bloomberg.net.

Last Updated: May 28, 2009 17:05 EDT