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Treasury Two-Year Yields Near 4-Week Low on Stocks' Decline, Fed Outlook

Treasury two-year yields stayed near the lowest level since May as a decline in stocks boosted demand for the safest assets amid speculation the Federal Reserve will keep interest rates near zero.

Investors favored fixed-income assets on bets that reduced inflationary pressure will prompt Fed policy makers to repeat pledges to keep borrowing costs low for an “extended period” when they meet this week. The Treasury will sell $40 billion in two-year notes today, $2 billion less than the previous offering. The MSCI World Index fell 0.3 percent, ending 10 days of stock gains, as comments by a European Central Bank official suggested some lenders may struggle to finance themselves.

“It’s likely that Fed policy will contribute to yields staying at fairly low levels for some time,” said Elwin de Groot, a senior market economist at Rabobank Groep in Utrecht, Netherlands. “We’ve seen a slight improvement in risk appetite, but the underlying tone remains downbeat.”

The two-year note yielded 0.71 percent as of 9:40 a.m. in London, according to BGCantor Market Data. The yield fell to 0.69 percent on June 17, the lowest since May 25. The 0.75 percent security due May 2012 traded at 100 2/32. The 10-year yield held at 3.25 percent.

The government will also sell $38 billion in five-year notes tomorrow and $30 billion in seven-year securities on June 24. Indirect bidders, an investor class that includes foreign central banks, bought 36 percent of the two-year notes at the prior auction on May 25, compared with an average of 42 percent over the past 10 sales.

‘Tightly Bid’

“The auction should be reasonably tightly bid,” said Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London. “Two-year auctions are generally not a great challenge for the market, particularly not in this current environment.”

The Federal Reserve will hold the benchmark interest rate at a record low range of zero to 0.25 percent at this week’s meeting, according to all of the 96 economists surveyed by Bloomberg News. Policy makers have kept the Fed funds rate unchanged since December 2008, and the “extended period” pledge has been in place since March 2009.

Investors anticipate an inflation rate of 1.69 percent in the next five years, compared with 2.01 percent on April 28, when policy makers concluded their last meeting on monetary policy, according to the difference in yield between five-year Treasuries and Treasury Inflation-Protected Securities.

‘European Overhang’

“The FOMC is not going to move, and the language is not going to change because it’s too early for the Fed to even contemplate moving rates,” said Kumar Palghat, who helps manage the equivalent of $1.6 billion at Kapstream Capital in Sydney. “Economic data in the U.S. is mixed and you still have the European overhang.”

European stocks declined, with the Stoxx Europe 600 Index ending a nine-day rally, falling 0.2 percent. The U.K.’s FTSE 100 Index fell 0.6 percent. BNP Paribas SA slid 1.9 percent after Fitch Ratings cut the credit rating for France’s largest bank. ECB governing council member Christian Noyer said some lenders are facing funding problems.

“Some banks have started facing increasing funding problems,” the ECB’s Noyer said at a conference in Paris yesterday. “The situation reflects a general state of uncertainty which, left unchecked, could have significant consequences on financial stability and the real economy, as was the case during the last part of 2008.”

To contact the reporter on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net

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