Dec. 31 (Bloomberg) -- Treasuries fell, trimming their biggest annual rally since 1995, as stocks rose after fewer Americans filed initial claims for jobless benefits and the Treasury said it may expand aid to the auto industry.

U.S. 10-year notes and 30-year bonds dropped the most in more than five weeks. Even so, yields on government debt held near record lows. Treasuries returned 14.9 percent in 2008, according to Merrill Lynch & Co.’s U.S. Treasury Master index, as a housing slump triggered the longest recession since 1982.

“This has been the most trying year that most people will ever live through,” said Ray Remy, head of fixed income in New York at Daiwa Securities America Inc., one of 17 primary dealers that trade with the Federal Reserve. “Time to end it.”

The yield on the 10-year note climbed 17 basis points, or 0.17 percentage point, the most since Nov. 21, to 2.22 percent at 2:58 p.m. in New York, according to BGCantor Market Data. The yield touched 2.0352 percent on Dec. 18, the lowest on record for data going back to 1953. The 3.75 percent security due in November 2018 tumbled 1 19/32, or $15.94 per $1,000 face amount, to 113 15/32.

The 30-year bond’s yield increased 15 basis points, also the most since Nov. 21, to 2.70 percent. Debt fell that day as stocks rebounded from an 11-year low after President-elect Barack Obama chose New York Fed President Timothy Geithner to head the Treasury. The 30-year yield was 2.5090 percent on Dec. 18, the lowest since regular sales began in 1977.

More Auto Aid

The two-year note’s yield rose six basis points to 0.77 percent. It fell on Dec. 17 to 0.6044 percent, the lowest since regular sales of the security began in 1975.

The 10-year yield may drop to 1.75 percent in the first quarter, said Marc Fovinci, head of fixed income at Ferguson Wellman Capital Management Inc. in Portland, Oregon, who helps invest $2.8 billion.

The Treasury said it drafted guidelines to provide funds to any company deemed important to making or financing cars.

Stocks advanced, trimming losses at the end of the market’s worst year since the Great Depression. The Standard & Poor’s 500 Index gained 1.6 percent.

“Stocks are higher, bonds lower -- it seems pretty rudimentary,” said Ian Lyngen, an interest-rate strategist in Greenwich, Connecticut, at RBS Greenwich Capital, another primary dealer. “There’s nothing else going on.”

Volume Down

Less than $55 billion in Treasuries changed hands as of 2:04 p.m. today, according to ICAP Plc, the world’s largest inter-dealer broker. That compared with a three-month full-day average of $208 billion.

The Securities Industry and Financial Markets Association recommended that Treasuries trading end today at 2 p.m. New York time for New Year’s Eve and stay shut around the world tomorrow for New Year’s Day, and in Japan on Jan. 2.

The number of Americans filing first-time claims for jobless benefits dropped by 94,000 to 492,000 in the week ended Dec. 27, from 586,000 the previous week, the Labor Department said today. Total jobless rolls jumped to a 26-year high in the prior week.

Demand for Treasuries this year reached the “bubble” phase seen in technology stocks in 2000 and real estate six years later, David Rosenberg, chief North American economist at Merrill Lynch, wrote in a note Dec. 1. He forecast the 10-year note’s yield could fall below 2.3 percent, which it did for the first time 15 days later.

With the economy losing 1.9 million jobs in the first 11 months of 2008, according to Labor Department data, others saw different factors behind the record low yields.

‘This Is Fear’

“Bubbles are born of greed; this is fear,” T.J. Marta, a fixed-income strategist at RBC Capital Markets in New York, said this week. The firm is the investment-banking arm of Canada’s biggest lender. “There’s nowhere else to run at this point. This is a lot more like Japan in the 1990s or the U.S. in the 1930s than the U.S. in the 1980s or 1970s.”

U.S. government securities trounced stocks in 2008 as the Fed cut interest rates to spur the economy and investors sought the safest securities. The S&P 500 index plunged almost 39 percent.

The dollar headed for its steepest annual decline against the yen in more than 20 years, dropping 19 percent, on bets the Fed’s zero target lending rate will curtail demand for the U.S. currency. The central bank lowered its benchmark to a range of zero to 0.25 percent, from 1 percent, on Dec. 16.

TED Spread

Yields indicate the rate reductions made banks more willing to lend than earlier in the year. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, narrowed to 1.35 percentage points from 2008’s high of 4.64 percentage points set in May. That was the most since Bloomberg began compiling the data in 1984.

Merrill Lynch indexes show that in 2008 the 10-year note returned 21.7 percent and the 30-year bond returned 44 percent, outperforming other maturities. Most of their gains came in the last two months of the year as the Fed said it will buy longer- term debt, possibly including Treasuries. The securities, among the most sensitive to inflation because of their long maturities, surged as the recession led traders to cut their outlook for prices in the economy.

The U.S. economy will have shrunk an annualized 4.35 percent in the fourth quarter of 2008 and return to growth in the second half of next year, a Bloomberg survey showed.

U.S. yields indicate traders expect almost no inflation for the next decade. The difference between yields on 10-year Treasury Inflation Protected Securities, or TIPS, and conventional notes, which reflects the outlook among traders for consumer prices, was 13 basis points.

The Treasury said it will auction $8 billion in 10-year TIPS on Jan. 6.

To contact the reporters on this story: Daniel Kruger in New York at dkruger1@bloomberg.net; Anchalee Worrachate in London at aworrachate@bloomberg.net.

Last Updated: December 31, 2008 15:02 EST