Treasuries Rise as Merrill Losses Raise Rate-Cut Speculation

By Deborah Finestone and Sandra Hernandez

Oct. 24 (Bloomberg) -- Treasuries rose for a second day as losses at Merrill Lynch & Co. increased speculation that weakness in the housing sector will prompt the Federal Reserve to lower interest rates next week.

Yields on two-year notes fell to near the lowest in more than two years after Merrill Lynch reported a larger-than- forecast $7.9 billion of writedowns for subprime mortgages and asset-backed bonds. Sales of previously owned U.S. homes fell to the lowest on record.

``People foresee that subprime contagion will slow economic growth to recessionary-type levels,'' said George Adell, a fixed- income strategist at Philadelphia-based Commerce Capital Markets. ``The only thing investors want is the safety of Treasuries.''

The benchmark 10-year note's yield fell 4 basis points, or 0.04 percentage point, to 4.37 percent at 10:14 a.m. in New York, according to bond broker Cantor Fitzgerald LP. The price of the 4 3/4 percent security maturing in August 2017 rose 9/32, or $2.81 per $1,000 face amount, to 103 1/32.

Two-year yields declined 2 basis points to 3.77 percent. They fell to 3.73 percent Oct. 22, the lowest since Sept. 2, 2005, when the aftermath of Hurricane Katrina drove investors to the safest debt. The government is scheduled to sell $20 billion of the securities today.

Merrill Loss

Merrill Lynch, the world's biggest brokerage firm, reported the highest writedowns by any Wall Street firm, exceeding the $5 billion forecast earlier this month.

Amazon.com Inc., the world's largest Internet retailer, fell on a fourth-quarter profit forecast that may miss some analysts' estimates.

The Standard & Poor's 500 Index fell 0.8 percent to 1,507.47.

``Investors are putting on a little bit of a risk aversion trade in the bond market,'' said David Keeble, London-based head of fixed-income strategy at Calyon, the investment banking arm of Credit Agricole SA, France's second-biggest bank. ``We're worrying about the banking sector at the moment.''

Interest-rate futures traded on the Chicago Board of Trade show a 98 percent chance the Fed will lower its target rate by a quarter-percentage point on Oct. 31 to 4.5 percent. The odds were 96 percent before the release of the data and 88 percent yesterday.

Treasuries extended gains after a report from the National Association of Realtors said existing-home sales fell 8 percent in September to an annualized rate of 5.04 million, the fewest since record keeping began in 1999, from a revised 5.48 million August pace. The median forecast of 76 economists surveyed by Bloomberg News was for a decline of 4.5 percent to 5.25 million.

`Weak Home Sales'

``Weak home sales will help Treasuries rally,'' said David Coard, head of fixed-income trading in New York at Williams Capital Group, a brokerage for institutional investors, before the data was released. ``Maybe the housing sector hasn't reached bottom yet.''

Gains may be limited before the Treasury's monthly auction of two-year notes. The $20 billion to be sold is the largest amount since January.

At last month's auction of $18 billion, investors bid for 3.29 times the amount of debt being sold. The average for the past 10 sales has been 2.95 times. The U.S. is also scheduled to sell $13 billion of five-year notes tomorrow. Bids are due at 1 p.m. New York time.

Yield Forecast

The two-year yield will climb to 4.03 percent by year-end, according to a Bloomberg survey of 72 economists, with the most recent forecasts given the heaviest weightings.

Two-year notes yielded 60 basis points less than 10-year securities, widening from 51 basis points two weeks ago. The increasing difference indicates greater demand for shorter maturities, those more sensitive to changes in monetary policy expectations.

Government debt was also buoyed by renewed speculation fighting between Turkey and Kurdish militants in northern Iraq will escalate.

Turkey bombed units of the Kurdistan Workers' Party, or PKK, in northern Iraq and sent troops across the border in pursuit of the militants, a lawmaker of Turkey's governing party said today.

``There will be a little safe-haven buying on the bombings,'' Keeble said.