Dec. 6 (Bloomberg) -- U.S. Treasury notes pared their declines in New York after an attack on the U.S. Consulate in Saudi Arabia fueled demand for the safety of government debt.

Gunmen assaulted the Consulate in Jeddah, Saudi Arabia's second-largest city, killing four Saudi guards and taking 18 people hostage, Reuters reported, citing unidentified security officials.

Treasuries erased their earlier losses after the attack was reported, said Deborah O'Neill, who trades U.S. government securities in Dublin for the Bank of Ireland.

The 4 1/4 percent note due in November 2014 rose 1/32, or 31 cents $1,000 face amount, to 100 1/32 at 7:55 a.m. in New York, according to New York-based bond broker Cantor Fitzgerald LP, leaving its yield little changed at 4.25 percent. It earlier rose as high as 4.27 percent. A basis point is 0.01 percentage point.

Demand for Treasuries was also fed by speculation that Japan will resume buying dollars and investing them in U.S. government debt in a bid to weaken the yen.

Japanese Vice Finance Minister Koichi Hosokawa said today that the government is prepared to ``act aggressively,'' on rapid moves in the yen. The Japanese currency has gained 3.2 percent versus the dollar in the past month, and on Dec. 2 rose to 101.83, its strongest since January 2000.

``Japanese officials have stepped up their rhetoric,'' said Christoph Rieger, a fixed-income strategist in Frankfurt at Dresdner Kleinwort Wasserstein. ``If they come back to the plate and intervene, it will make a difference to Treasuries.''

Japan, which spent a record 14.8 trillion yen ($140 billion) in the first quarter buying dollars, is the largest foreign holder of Treasuries, accounting for $720.4 billion of the securities as of September, according to Treasury figures.

BIS Report

Ten-year notes fell earlier after the Bank of International Settlements said central banks in Asia may be adding to their euro holdings, raising speculation a sliding dollar is cutting demand for government securities.

Newspaper reports saying Taiwan's central bank and Japan's Ministry of Finance are considering trimming their dollar holdings fed concern a decline in the currency is souring some investors on U.S. assets. Officials from Taiwan and Japan denied the reports.

``Investors are more reluctant to hold dollar assets and that is negative for Treasuries,'' said Yoshitaka Majima, who oversees $4 billion in bonds at Merrill Lynch Investment Management in Tokyo, a unit of the world's biggest securities firm by capital. ``They want more risk premium before buying.''

Declining Dollar

Ten-year yields may rise to 4.5 percent in the months ahead, Majima said. He said he holds short positions in Treasuries, which means he borrowed and sold securities in anticipation of making a profit by buying them back after their prices fall.

Waning demand for U.S. securities in August ``was seen by some market participants as confirmation that Asian central banks and oil exporters were diversifying out of dollars and into euros,'' the Basel, Switzerland-based BIS said.

``There is still downside pressure on Treasuries as long as the dollar keeps on declining,'' said Akio Shimizu, a trader in Singapore at Mitsubishi Trust & Banking Corp., a unit of Japan's second-largest lender by assets. The U.S. 10-year yield will probably rise to 4.4 percent, he said.

The dollar index, a measure of the U.S. currency against a basket of six currencies of its trading partners, dropped 8.7 percent since June.

`Enormous Capital Flight'

Japan urged the U.S. to take coordinated action to stop the dollar's decline, or it will face an ``enormous capital flight,'' the U.K.'s Observer newspaper said on its Web site, citing Kaoru Yosano, head of the Liberal Democratic Party's policy council.

Japan has no plan to divert from dollar-denominated assets, Masatsugu Asakawa, a Ministry of Finance official, said later.

Taiwan's central bank ``categorically denies'' a Dec. 4 report by the Liberty Times in Taipei that the island may pare U.S. assets, according to a statement issued on the bank's Web site.

A Ried, Thunberg & Co. survey showed Treasury investors are more bearish than last week, with its index measuring the outlook for the 10-year note on Dec. 3 falling to 38 from 39 a week earlier, matching the lowest of the year.

Readings below 50 mean investors expect the note to drop by April. The 41 investors polled by the Jersey City, New Jersey- based bond research firm manage $1.33 trillion.

The Treasury will today announce the amount of 5- and 10- year notes it will sell this week. Analysts polled by Bloomberg News expect $15 billion of five-year notes and $9 billion of 10- year notes in a reopening of the security auctioned Nov. 10.

Jobs Report

The yield on the 10-year note fell 16 basis points on Dec. 3, the biggest drop since August, after the Labor Department said 112,000 jobs were added last month, less than the median estimate of 200,000 in a Bloomberg News survey of economists.

The report raised concern about ``the strength of the U.S. economic recovery, and demand at the auctions will remain firm,'' said Seiji Shiraishi, chief market economist in Tokyo at Daiwa Securities SMBC Co., a subsidiary of Daiwa Securities Group Inc., Japan's second-largest brokerage. He forecasts yields will rise to 4.5 percent by year-end.

A falling dollar also can help quicken inflation by making imported goods more expensive. Inflation erodes the value of a bond's fixed payments.

All 22 primary dealers forecast that the Fed will raise borrowing costs for a fifth time this year by a quarter percentage point, taking its rate to 2.25 percent, when policy makers next meet on Dec. 14.

Fed funds futures show traders are pricing in about a 97 percent chance of a 2.25 percent rate by year-end. December federal funds futures, bets on what the central bank's target rate will average in a particular month, yielded 2.14 percent.

Traders have priced in an 88 percent chance of another quarter percentage point rate increase when the policy makers meet for the first time next year on Feb. 2.

``I'm still bearish on Treasuries as the Federal Reserve will keep on raising interest rates to reduce inflation risks,'' Mitsubishi Trust's Shimizu said.