reasuries snapped a three-day gain on speculation the rally that pushed U.S. government securities to their best year since 2008 will give way to losses in 2012 as the economy improves.

U.S. debt returned 9.6 percent in 2011 as of yesterday, according to Bank of America Merrill Lynch data, even after Standard & Poor's cut the nation's AAA rating on Aug. 5. German bunds also gained 9.6 percent, Japanese bonds advanced 2.1 percent and U.S. corporate debt rallied 6.6 percent. Treasuries, driven higher this year by demand for safety during the European debt crisis, are poised to beat stocks, commodities and the dollar for the year.

“Treasury yields at current levels are not adequately reflecting the U.S. growth outlook and inflation risk,” said David Schnautz, a fixed-income strategist at Commerzbank AG in London. “They are currently distorted by haven demand driven by the euro debt crisis. But at some point, the U.S. economic fundamentals will become a focus again.”

The 10-year yield was little changed today at 1.90 percent at 8:42 a.m. in London, according to Bloomberg Bond Trader prices. The 2 percent note due in November 2021 fell 1/32, or 31 cents per 1,000 face amount, to 100 27/32. Two-year yields were also little changed at 0.28 percent.

Commerzbank predict the 10-year yield will rise to 2 percent in the next three months, and reach 2.90 percent by the end of 2012.

Eoin Treacy's view My view – 2011 has been marred by concerns about the Eurozone's credit markets, China's property markets, a slow return to growth in the USA, political upheaval across the Middle East and extreme volatility in stock markets. As a result investors have put a premium on liquidity and displayed a preference for US, German, UK and Japanese sovereign debt. A number of yields have hit historic lows, reflecting a rather pessimistic attitude towards economic prospects. If for any reason this expectation of a worst case scenario proves incorrect, attitudes towards the above government debts could change quickly.

US 2-year yields have been ranging with a downward bias for much of the last 3 years. Yields has paused between 0.2% and 0.3% since October and retested the latter earlier this week. They will need to sustain a move above 0.3% to begin to indicate supply is returning to dominance beyond the short term. The 10-year posted new lows in September and continues to range near 2% in a relatively gradual mean reversion. A sustained move above 2.45% will be required to suggest a return to medium-term supply dominance.

UK 2-year yields failed to sustain the rally above 1.3% at the beginning of the year and have trended consistently lower since. The rate continues to post new lows and while oversold in the short-term a break in the progression of lower rally highs, with a sustained move above 0.6%, will be required to challenge the consistency of the decline. UK 10-year yields sustained a break below the psychological 3% in July and fell through 2% this week. While at historically low levels, a sustained move above 2.5% will be required to suggest supply is returning to dominance.

The German 2-year continues to trend lower and a sustained move above 0.4% will be required to check demand dominance. German 10-year Bunds also broke decisively below 3% this year. The yield completed a reversion towards the mean in October but will need to sustain a move above the 200-day MA, currently in the region of 2.5% to question the medium-term downward bias.

Australia reversed its tightening bias in the last quarter and additional rate cuts appear more likely than not. The 2-year yield exhibits a similar pattern of demand dominance to the US 2-year above. The 10-year continues to trend consistently lower and while oversold in the short-term a clear upward dynamic, sustained for more than a week or two, would be required to suggest more than temporary demand dominance.

The Swiss 2-year has been ranging in the region of 0% since late August. Additional downside is limited while a sustained move above 0.1% would likely suggest a return to medium-term supply dominance. The 10-year remains in a relatively consistent downtrend and a sustained move above 0.95% would be required to challenge the progression of lower rally highs.

The Canadian 2-year returned to test the 2009 lows near 1% in August and continue to range around that level in a relatively gradual reversion towards the 200-day MA. A sustained move above 1.2% would be required to suggest a return to supply dominance. The 10-year continues to trend lower in line with most of the above yields of similar duration.

A trend of flattening yields curves is evident in the above charts. Yields at the short end of the curve are mostly static while longer-dated yields are compressing. 10-year – 2-year spreads for the USA, UK and Germany have topped out and look set to compress further. Swiss, Canadian and Australian spreads are in more advanced downtrends. Widening yield curve spreads are generally associated with loose monetary policy and increasing appetite for risk. Contracting spreads suggest the opposite. With most central banks committed to low interest rates and increasing liquidity, much of the above yield curve flattening appears to be driven by risk aversion buying of sovereign debt. This is not sustainable indefinitely and it is likely to be obvious on the above charts when a change occurs.