March 26 (Bloomberg) -- Treasuries rose for the first time in more than a week on speculation a government report will show the U.S. economy shrank more than previously estimated and as the Federal Reserve prepared to buy more of the securities.

The central bank plans to purchase notes due from March 2011 to April 2012 tomorrow, after scooping up $7.5 billion of U.S. debt yesterday. The U.S. recession will lead the Fed to hold down borrowing costs, according to Kokusai Asset Management Co., which runs Japan’s biggest bond fund. Gains were capped before a $24 billion seven-year auction today.

“The Fed will keep the policy rate at almost zero percent,” said Masataka Horii, one of four investors for the $47.4 billion Kokusai Global Sovereign Open Fund in Tokyo. “Yields will stay around this level.”

The 10-year yield declined two basis points to 2.78 percent as of 2:52 p.m. in Tokyo, according to BGCantor Market Data. The price of the 2.75 percent security due in February 2019 gained 6/32, or $1.88 per $1,000 face amount, to 99 3/4. A basis point is 0.01 percentage point.

The yield, which fell to a record 2.04 percent on Dec. 18, averaged 4.26 percent for the past five years. Global Sovereign Open returned 4.1 percent the past month, versus an average of 3.3 percent for its peers, data compiled by Bloomberg show.

Gross domestic product shrank at a 6.6 percent annual rate from October to December, the most since 1980, according to the median forecast in a Bloomberg News survey of economists before the Commerce Department report today. The government estimated a 6.2 percent decline a month ago.

Jobless Claims

The Labor Department will say first-time claims for unemployment insurance rose to 650,000 in the seven days ended March 21 from 646,000 the previous week, a separate Bloomberg survey showed. International Business Machines Corp., the world’s biggest computer-services provider, is cutting about 5,000 jobs, according to a person familiar with the matter, joining Microsoft Corp. and Intel Corp. in trimming payrolls.

The U.S. economy will be in period of deflation by the end of 2010, wrote Seamus Smyth, an economist at Goldman Sachs Group Inc. in New York, in a report distributed yesterday in the U.S. Deflation, a general decline in prices, is good for bonds because it enhances the value of their fixed payments. Goldman is one of the 16 primary dealers required to bid at government debt sales.

Inflation Slows

The economic contraction helped limit gains in U.S. consumer prices to 0.2 percent in the 12 months ended Feb. 28, meaning 10-year notes yield 2.58 percent after inflation. The so-called real yield is more than double the five-year average.

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, which reflects the outlook among traders for the cost of living, was 1.40 percentage points, versus a five-year average of 2.27 percentage points.

The recession helped U.S. government securities return 1.5 percent so far in March, based on Merrill Lynch & Co.’s U.S. Treasury Master index. That rally helped trim the first-quarter loss to 2.2 percent, as rising government debt sales drove the market to its worst start to a year since 1996.

Ten-year notes fell the most in more than two weeks yesterday as a $34 billion five-year sale drew a yield of 1.849 percent, higher than the 1.801 percent forecast in a Bloomberg News survey of eight trading firms.

“Supply is overwhelming the market,” said Satoshi Okumoto, general manager in Tokyo at Fukoku Mutual Life Insurance Co., which has $58.2 billion in assets. “Yields should rise.” The insurer, which sees 10-year rates climbing to 3.5 percent by year-end, trimmed its holdings of Treasuries over the past 12 months, Okumoto said.

Record Sales

The Treasury Department is selling a record $98 billion in notes this week. The U.K. failed to attract enough bidders yesterday at an auction of 1.75 billion pounds ($2.55 billion) of gilts for the first time in almost seven years.

“In light of all the supply that’s in the market, it’s not a surprise that yields have moved back up,” said Jeffrey Caughron, an associate partner in Oklahoma City at The Baker Group Ltd., which advises community banks investing $20 billion of assets. “You don’t want to fight the Fed. Even though there is enormous supply, the Fed will do what it can to keep a cap on yields.”

Policy makers on March 18 announced plans for the Fed’s first targeted government debt purchases since the 1960s, aiming to hold down borrowing costs.

President Barack Obama’s government is selling record amounts of debt to revive economic growth, service deficits, and cushion the failures in the financial system. Debt sales will almost triple this year to a record $2.5 trillion, according to estimates from Goldman.

Credit Markets

Yields indicate government and central bank plans to spur the economy haven’t restored credit markets to where they were before tumbling last year.

The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, widened to 104 basis points from 91 basis points on Feb. 10. The spread averaged 36 basis points in 2006, the last year before the credit crunch started.

U.S. company bonds yielded 7.93 percentage points more than Treasuries, widening from 4.06 percentage points a year ago, Merrill’s Corporate & High Yield Master index shows.

San Francisco Fed Bank President Janet Yellen said yesterday that the central bank wants authority to issue its own debt, a move that would strengthen its efforts to raise interest rates as the credit crisis abates.

The Fed normally increases rates by selling Treasuries on its balance sheet, draining reserves from the banking system. That task is tougher with its commitment last week to buy more than $1 trillion in mortgage-backed securities, which are harder to sell quickly without roiling markets.

The central bank switched its focus to emergency credit programs after cutting its target for overnight lending between banks to a range of zero to 0.25 percent in December. It plans to buy a total of $300 billion in Treasuries.

To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.

Last Updated: March 26, 2009 01:55 EDT