July 2 (Bloomberg) -- Treasury notes gained, with two-year yields falling below one percent for the first time in almost a month, after a government report showed the U.S. economy lost more jobs than forecast in June.

Two-year notes gained for a second day after the Labor Department said employers eliminated an additional 467,000 jobs last month and the unemployment rate rose to 9.5 percent. The Treasury announced plans to sell $73 billion in notes and bonds next week, below the average forecast of five trading and research firms surveyed by Bloomberg News. The so-called yield curve was the steepest since June 23.

“This report suggests we are a ways away from a more favorable trend in the labor markets generally,” said Christopher Sullivan, who oversees $1.4 billion as chief investment officer at United Nations Federal Credit Union in New York. “Treasuries found support.”

The two-year note yield fell six basis points, or 0.06 percentage point, to 0.99 percent at 4:18 p.m. in New York, according to BGCantor Market Data. This is the first time the yield has dropped below 1 percent since June 5. The price of the 1.125 percent security due in June 2011 rose 3/32, or 94 cents per $1,000 face value, to 100 1/4.

The 10-year note yield fell five basis points to 3.50 percent.

Ten-year yields will climb to 3.63 percent and two-year yields will increase to 1.39 by year-end, according to a Bloomberg survey.

Payroll Decline

Payrolls were forecast to drop 365,000, according to the median of 79 economists surveyed by Bloomberg News. The decline followed a revised 322,000 decrease in May, according to Labor Department figures released in Washington. The jump in the jobless rate takes it to the highest since August 1983.

“The numbers were market favorable with the payrolls number being higher and reversing last month’s good number,” said John Spinello, chief technical strategist in New York at Jefferies Group Inc., one of 16 primary dealers that trade with the Federal Reserve.

The yield on the two-year note soared more than 30 basis points to as high as 1.31 percent on June 5 after the government said employers cut fewer jobs than expected in May, spurring speculation that the central bank might tighten monetary policy this year.

The Treasury will sell three so-called coupon issues and an inflation-indexed maturity in a single week for the first time since the Treasury started issuing securities regularly in 1976.

Treasury Auctions

The government will offer $8 billion of 10-year Treasury Inflation Protected Securities on July 6, $35 billion of 3-year notes on July 7, $19 billion of 10-year notes on July 8 and $11 billion of 30-year bonds on July 9, the department said today. The U.S. was expected to offer $75.6 billion of debt, according to the Bloomberg News survey.

The Treasury is “working aggressively to extend the average maturity of its debt as it tries to meet the rise in financing needs in as stable a fashion as possible,” said Louis Crandall, chief economist at Wrightson ICAP LLC, a Jersey City, New Jersey-based research firm.

President Barack Obama has pushed the nation’s marketable debt to an unprecedented $6.45 trillion in an effort to spur economic growth, support the financial system and service record deficits. The budget shortfall is projected to increase to $1.85 trillion in the year ending Sept. 30, equivalent to 13 percent of the nation’s economy, according to the nonpartisan Congressional Budget Office.

Inflation Pressures ‘Subside’

The weakened economy has bolstered expectations the central bank will keep its benchmark lending rate near zero for the rest of the year. Traders cut bets that the central bank will tighten monetary policy, predicting a 26 percent probability that officials will increase rates by November, down from a 67 percent chance after last month’s employment report.

Fed policy makers kept the benchmark lending rate at a range of zero to 0.25 percent at their June meeting. San Francisco Fed Bank President Janet Yellen said this week the central bank may hold the rate near zero for several years.

“The Fed is in no rush to raise rates,” said Alex Li, an interest-rate strategist in New York at primary dealer Credit Suisse Securities USA LLC. “There is no wage inflation pressure so that gives policy makers less reason to consider any rate hikes anytime soon.”

The gap between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, narrowed to 1.65 percentage points today, the least since May 19. It reached a high of 2.08 percentage points June 10.

‘Pain Trade’

The difference between 10-year notes and two-year debt, known as the yield curve, rose to 2.51 percentage points today, after reaching a five-week low of 2.38 percentage points June 29.

Despite the recent steepening, the yield curve will flatten, according to David Brownlee, head of fixed income at Sentinel Asset Management in Montpelier, Vermont, which manages $18 billion.

“There is clearly plenty of room to decline,” Brownlee said. “There’s an old adage that the market always moves in the direction to inflict the most pain. The pain trade in the bond market is a bullish flattener with the long end coming down.”

Treasuries lost 4.46 percent through June, and are on a pace to post an annual loss for only the third time since Merrill Lynch & Co. started calculating returns with its U.S. Treasury Master index in 1978. The index rose 14 percent last year as the global economy lapsed into the worst recession since World War II.

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

Last Updated: July 2, 2009 16:30 EDT