Jan. 27 (Bloomberg) -- Treasuries rose, with longer- maturity securities gaining for the first time in seven days, after a record auction of two-year notes drew a lower yield than traders forecast.

Two-year Treasury note yields fell from near the highest level in almost three weeks after the government sold $40 billion of the securities at a yield of 0.925 percent, close to the yield in pre-auction trading. U.S. debt has dropped 2.2 percent in January so far, according to a Merrill Lynch & Co. index, as investors braced for a record amount of securities this year. The Federal Reserve began a two-day meeting to decide the next step in monetary policy to spur the economy.

“It’s just a fairly successful auction,” said Brian Edmonds, head of interest rates at Cantor Fitzgerald LP in New York, one of 17 primary dealers that are required to bid in Treasury sales. With the central bank’s benchmark interest rate at a range of zero to 25 basis points, “the front end of the curve will be the easiest place for us to bring supply.”

Thirty-year bond yields tumbled 12 basis points, or 0.12 percentage point, to 3.25 percent at 4:11 p.m. in New York, according to BGCantor Market Data. The 4.5 percent security maturing in May 2038 climbed 2 21/32, or $26.56 per $1,000 face amount, to 123 14/32. The yields climbed 45 basis points last week, the most since 1987.

Two-year Treasury note yields fell three basis points to 0.81 percent. Ten-year note yields dropped 11 basis points to 2.54 percent.

Two-Year Auction

The two-year note auctioned today, which matures in January 2011, drew a yield of 0.926 percent in pre-sale trading. The average forecast of eight bond-trading firms in a Bloomberg News survey was for a yield of 0.939 percent.

Investors bid $2.69 for every $1 on offer, a sign of greater demand than at the last auction, when they bid $2.13 for every $1. The average ratio for the past 10 sales before today is $2.31. Indirect bidders, a group that includes foreign central banks, bought 34.6 percent of the amount sold, compared with 30.4 percent in the last auction.

“There was a lot of fear in the street that this was the largest coupon auction ever, and I’m sure some dealers thought” the debt would sell at a yield higher than where the notes were trading before the sale, said Chris Ahrens, an interest-rate strategist at UBS Securities LLC in Greenwich, Connecticut, a primary dealer.

The auction was the second of three sales of coupon securities scheduled for this week. The government sold $8 billion in 20-year Treasury Inflation-Protected Securities yesterday at higher-than-expected yields and will sell a record $30 billion of five-year notes Jan. 29.

Yield Curve

Goldman Sachs Group Inc., another primary dealer, said last week the U.S. will probably borrow a record $2.5 trillion this fiscal year ending Sept. 30, versus $892 billion in notes and bonds sold during the prior 12 months.

Yields on 10-year notes fell more quickly than those on two-year notes, sending the yield gap between the two securities to the lowest in a week. The so-called yield curve narrowed by nine basis points to 1.72 percentage points.

“You might have some profit-taking in the two-year, 10- year trades that existed,” said John Spinello, chief technical strategist in New York at Jefferies Group Inc. The 10-year note was “pretty dramatically oversold, and we have managed to hold at 2.68 percent for the past few days.”

The 10-year note will trade in a range between 2.55 percent and 2.68 percent over the next few days, Spinello said.

Treasuries have fallen this month the most since April 2004, when they handed investors a 3.2 percent loss, according to the Merrill Lynch index.

Investors More Bearish

Investors were more bearish about government debt this week than last, according to a weekly poll of clients by JPMorgan Chase & Co. The number of investors betting on a jump in note prices fell to 16 percent from 18 percent last week. Investors forecast falling prices over rising prices by the most since the week of Dec. 8.

“The big demand and the big push and the big money flow into Treasuries has likely occurred,” said Ross Junge, who helps manage about $36 billion as head of portfolio management at Aviva Investors North America in Des Moines, Iowa. “We don’t think you are being paid to own Treasury securities at these levels.”

In short-term lending, the $1.69 trillion commercial paper market may be the first to cut its reliance on federal bailout programs. About $245 billion of 90-day commercial paper that companies sold to the Fed starting in October will mature this week and next, central bank data show.

Inflation Expectations

Confidence among U.S. consumers unexpectedly fell in January to a record low reading, 37.7, a Conference Board report showed today. Home prices in 20 U.S. cities dropped 18.2 percent in November from a year earlier, the fastest on record, the S&P/Case-Shiller index showed.

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, which reflects the outlook among traders for consumer prices, widened to 80 basis points from minus eight basis points in November. The average for the past decade is 2.11 percentage points.

To contact the reporters on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net; Daniel Kruger in New York at dkruger1@bloomberg.net.

Last Updated: January 27, 2009 16:18 EST