Bonds fall as Fed leaves rates steady

'Are You a Stock or a Bond?'

More Videos

Quick Vote

What do you think of the Fed's interest rate decision?

• On the right track
• Won't help economy
• Not sure

or View results

NEW YORK (CNNMoney.com) -- Treasurys danced around, then turned lower Tuesday as the Federal Reserve held rates steady and nervousness mounted on Wall Street.

In a Federal Reserve meeting Tuesday, the interest-rate setting Federal Open Market Committee decided to leave its key rate at 2%.

That decision helped move bonds down, as investors had priced in a rate cut of a quarter-percentage point, according to Scott Anderson, senior economist with Wells Fargo.

"The market had fully priced in the cut, but obviously that didn't happen," said Anderson. "That's getting factored in to declining bond prices as the market starts to rethink the Fed's interest rate strategy."

Before Monday's market meltdown, economists had widely expected the central bank to hold the Fed funds rate steady. But many analysts began to predict a rate cut of at least a quarter-percentage point after Wall Street suffered its worst day in seven years.

Rate cuts tend to weigh negatively on the bond market, as they drive inflation higher, weakening the dollar.

The 10-year note fell 26/32 to 104 11/32, and its yield rose to 3.48% from 3.40% late Monday. Bond prices and yields move in opposite directions.

Shortly after the stock market opened, continued market jitters sent the 10-year yield sliding to 3.25%, the lowest level the benchmark note has reached since June 2003.

Bond prices then wavered for much of the day, and then fell after the Federal Reserve decision, sending the benchmark yield rising from its low.

The 30-year bond fell 1 5/32 to 107, and its yield rose to 4.09% from 4.04%. The 2-year note fell 11/32 to 100 29/32, and its yield rose to 1.91% from 1.75%.

Government bonds also responded to a rising equity market, which cheered the Fed's decision and set aside the nervous sentiment that pervaded the market for much of the day. Equities floated around the break-even point Tuesday but then rose after the Fed's announcement.

Many investors remain worried that Washington Mutual (WM, Fortune 500) and AIG (AIG, Fortune 500) could suffer the same fate as Lehman Brothers (LEH, Fortune 500), which filed for bankruptcy early Monday morning. Treasurys soared Monday on stocks' worst day since the attacks on Sept. 11, 2001.

But the fact that the Fed did not panic over Wall Street's crisis - and issued a unanimous decision to keep rates steady - helped boost sentiment in the markets.

"The Fed's decision gives the market a lot of ammunition in terms of liquidity," said Peter Cardillo, senior economist with Avalon Partners. "It helps keep dollar strong, and signals that while economy is slowing, we're not getting to point of recession - that's why the market is cheering the news."