Bonds skyrocket on Fed's $300B pledge

Bond prices spike after Federal Open Market Committee says it will purchase long-term Treasurys over the next six months.

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By David Goldman and Catherine Clifford, CNNMoney.com staff writers

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NEW YORK (CNNMoney.com) -- Treasury prices surged Wednesday, after the Federal Reserve said it would buy up to $300 billion in long-term Treasurys - a move the central bank has hinted at for months.

By 4:46 p.m. ET, the yield on the benchmark 10-year note had plummeted more than 0.5 percentage points to 2.499% from 3.01% late Tuesday, the largest single-day drop since Oct. 20, 1987.

The price of the 10-year note rose 4 14/32 to 102 7/32. Treasury prices and yields move in opposite directions.

The 30-year long bond skyrocketed 5 points immediately following the announcement, while the yield, which moves opposite to price, tumbled. At one point, the price surged more than 7 points before easing.

By late afternoon, the 30-year bond was trading up 5 11/32 to 99 18/32 and its yield had dropped to 3.53%, down from 3.82% late Tuesday.

The 2-year note rose 14/32 to 100 5/32 with a yield of 0.8%, down from 1.04%.

The 3 month bill yielded 0.21%, down from 0.23% Tuesday.

In addition to buying up long-term Treasurys, the Fed said it would purchase an additional $750 billion in mortgage-backed securities.

"[The Fed] gave the long end of the Treasury market the ultimate Christmas/holiday gift card [by] announcing a huge buying program which also includes U.S. Treasury debt," said Kevin Giddis, the head of fixed income at Morgan Keegan in a research note.

Many interest rates on various forms of debt are tied to long-term Treasury yields, including 10-year mortgage rates. The Fed has been exploring all of its options in an effort to lower interest rates after it lowered its rate to a range of 0.25% to 0%.

The Fed's policy-making arm, the Federal Open Market Committee, kept rates unchanged but said it decided to go forward with buying longer-term Treasurys over the next six months "to help improve conditions in private credit markets."

Furthermore, by buying up more bonds, the Fed may be able to inject some life into a market that has been slumping all year on worries that investors' demand for government debt will not be sufficient to match the huge influx of supply. To finance its unprecedented and expensive economic rescue efforts, the Treasury expects to issue between $2.7 trillion and $4.2 trillion in bonds in the next two years.

Giddis said that the longer term implications of the Fed's commitment could be severe.

"We commit the funds, bail out the ones that need a bailout out, issue the debt, and then drive all costs down by bringing in the biggest buyer in the world, the Federal Reserve of the United States," said Giddis. "When this roller coaster reaches the top and turns down, you better hold on tight because something is going to blow."

Lending rates: The 3-month Libor rate fell to 1.29% from 1.3% Tuesday, according to data on Bloomberg.com. The overnight Libor rate held steady at 0.31%.

Libor, the London Interbank Offered Rate, is a daily average of rates that 16 different banks charge each other to lend money in London.

Two credit market gauges were mixed. The "TED" spread rose to 1.08 percentage points from 1.07 points. The narrower the TED spread, the more willing investors are to take risks.

The Libor-OIS spread held steady at 1.07 percentage points. A narrower spread indicates that more cash is available for lending. To top of page

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