(Corrects date of widest yield spread in fifth paragraph, VIX increase in 10th.)

July 16 (Bloomberg) -- Treasuries rose for the first time in four days after CIT Group Inc. said it probably won’t receive a federal bailout, spurring demand for safer assets.

The gains sent 10-year yields down from a three-week high before the Federal Reserve buys debt maturing between 2010 and 2032 today as part of efforts to keep down borrowing costs. Most Fed officials last month said the economy may suffer further shocks even as they rejected an expansion in asset purchases, minutes of their June 24 meeting released yesterday showed.

“CIT is an ongoing reminder of the fragility of the system,” said Charles Diebel, head of European rate strategy at Nomura International Plc in London. “Also there isn’t enough out in terms of positive outlook to think that equities are going to rally from here. The U.S. economy is still in trouble and Treasuries could correct further to the upside.”

The yield on the 10-year note fell 2 basis points, or 0.02 percentage point, to 3.58 percent as of 8:57 a.m. in London, according to BGCantor Market Data. The rate reached 3.63 percent yesterday, the highest since June 25. The price of the 3.125 percent security maturing in May 2019 rose 6/32, or $1.88 per $1,000 face amount, to 96 9/32.

The difference between yields on two-year and 10-year notes widened to 2.61 percentage points today, the most since June 4. The so-called yield curve may steepen to record levels as the U.S. economy recovers, according to Pacific Investment Management Co., which runs the world’s biggest bond fund.

Steeper Yield Curve

A yield curve plots the rates of bonds of the same quality, but different maturities. It steepens when yields on shorter- maturity notes fall, those on longer-dated bonds rise, or both happen simultaneously. The spread typically increases when investors anticipate a recovery because they demand more compensation for the risk that growth will spark inflation.

“Long-term rates will rise at a faster speed than short- term rates,” Pimco portfolio manager Tony Crescenzi wrote in a report distributed by e-mail early in the Asian trading day. “Market participants decided months ago that the Armageddon scenario was out and stabilization was in.”

Crescenzi’s forecasts differ from analysts estimates in a Bloomberg survey that signal the gap will narrow to 2.41 percentage points by the end of September.

Treasuries rose after CIT said yesterday in a statement that “there is no appreciable likelihood of additional government support being provided over the near term.” The New York-based company, once the biggest independent commercial lender, faces bankruptcy if no federal aid emerges, Standard & Poor’s said earlier this week. CIT has battled cash shortages and faces $1 billion of bonds maturing next month.

No Government Support

The VIX Index, a measure of stock-market volatility known as Wall Street’s fear gauge, surged 3.5 percent yesterday, the first increase in five days.

Treasury bears say signs of recovery in the world’s largest economy will encourage investors to seek higher-yielding assets, drawing money away from U.S. debt.

Industrial production in the U.S. fell 0.4 percent in June, the slowest pace in eight months, after a revised 1.2 percent drop in May, Fed figures showed yesterday. The Federal Reserve Bank of New York’s gauge of manufacturing in the New York region climbed to minus 0.6 in July, the highest since April 2008.

“Good news for the economy has emerged and will continue to weigh on the Treasury market,” said Satoshi Okumoto, a general manager at Fukoku Mutual Life Insurance Co. in Tokyo, which has the equivalent of $61.4 billion in assets. “Stay out of the market. The volatility is a very, very huge risk.”

Mortgage Rates

Merrill Lynch & Co.’s MOVE Index, which measures price swings in Treasuries based on prices of over-the-counter options maturing in two to 30 years, rose for a third day to 151.80 yesterday. That’s the highest level in two weeks.

Ten-year yields may rise to as high as 4 percent by the end of the year, Fukoku’s Okumoto said.

A 26 basis point increase in 10-year yields so far this week has pushed mortgage rates higher, which may prompt holders of the securities to sell government debt used as a hedge to protect portfolios against rising interest rates.

U.S. 30-year fixed mortgage rates advanced to 5.41 percent yesterday from 2009’s low of 4.85 percent in April, according to Bankrate.com in North Palm Beach, Florida.

As mortgage rates rise, the expected average lives of mortgage bonds extend as potential refinancing drops, leaving holders with portfolios of longer-than-anticipated durations. Duration is a measure of bond price sensitivity to interest-rate change.

‘Lacks Conviction’

Minutes from the Fed’s June meeting show central bankers are less certain than they were in April over how the economy will emerge from the worst recession in a half century. Growth estimates from 10 FOMC members for next year clustered in ranges above 2.7 percent, while seven were in ranges of 2.5 percent or below.

“The committee as a whole lacks conviction about where the economy is going,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. “Uncertainty has to make them slower to start warning about a turning point in policy.”

Central bankers left the benchmark lending rate in a range of zero to 0.25 percent last month and said the policy rate was likely to remain “exceptionally low” for an “extended period.”

The London interbank offered rate, or Libor, for three- month dollar loans has fallen to 0.51 percent from 1.58 percent the day the Federal Reserve last reduced interest rates on Dec. 17, the British Bankers’ Association said yesterday. Libor is 26 basis points more than the upper end of the Fed’s target range for overnight loans between banks, near the least since March 2008.

The Libor-OIS spread, which measures banks’ willingness to lend, narrowed to 32 basis points, from a record 364 basis points in October.

To contact the reporters on this story: Anna Rascouet in London at arascouet@bloomberg.net; Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net.

Last Updated: July 16, 2009 06:30 EDT