Bonds twist after Operation Twist

10-Year Treasury yields fall to all-time lows on Fed's announcement of Operation Twist.

NEW YORK (CNNMoney) -- Bonds contorted further after the Federal Reserve officially announced a plan to buy long-term Treasuries and sell short-term securities Wednesday, a program being dubbed Operation Twist by the market.

The Fed hopes that Operation Twist will lower long-term interest rates broadly. The central bank will purchase $400 billion of Treasuries with maturities between 6 and 30 years before the end of June 2012 and will sell the same amount with maturities of 3 years or less.

Bond investors immediately acquiesced, pushing prices of long-term Treasuries up and yields down. The 10-year Treasury yield hit a record low of 1.858% while 30-year Treasury yields dropped to 3.01%.

Yields on the 2-year Treasuries increased to 0.19%. In anticipation of Operation Twist, the gap between 2 and 10-year Treasuries had narrowed.

The Fed will concentrate the majority of its reinvestment in Treasuries with maturities between 6 and 10 years with 32% going to 6-8 year Treasuries and 32% into 8-10 year maturities.

Analysts and investors say this move makes sense as most corporations and consumer borrow funds within that time horizon.

More perplexing to analysts was the Fed's decision to allocate 29% of its portfolio to buying Treasuries with 20 to 30-year maturities. The Fed issues significantly fewer new 30-year Treasuries each month, so it's essentially planning to buy almost all new issuances before June 30, 2012.

"There's more economic logic to allocating the purchase amount at the 6 to 10-year part of the yield curve because so much borrowing goes on there," said TCW's Rivelle.

The Fed will buy just 4% of 10-20 year Treasuries and will use the remaining 3% to buy Treasury Inflation-Protected Securities or TIPS.

The Fed also reversed course a bit on what it planned to do with mortgage bonds. The central bank said it was committed to using the government's balance sheet to prop up the housing market.

In its statement following its two-day committee meeting, the Fed said it would reinvest proceeds from its holdings of mortgage-backed securities into the mortgage market.

"This is an agreement to continue QE2 in a low-grade way," said Tad Rivelle, chief investment officer for fixed income at TCW.

While the Fed isn't actually expanding its bond purchasing power, it is maintaining a foothold in the housing market after previously indicating it planned to unwind positions in Fannie Mae, Freddie Mac and Ginnie Mac taken during the financial crisis in 2008 and 2009.

"It's a big change in direction on housing for the Fed," said Guy LeBas, chief fixed income strategist at Janney Capital Markets. "It's subtle but significant."

In its statement, the Federal Reserve Open Market Committee said: "This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative."

The FOMC cited the slow growth in the economy but stable longer-term inflation expectations as two key reasons for choosing Operation Twist over other possible monetary policy bullets.

But investors questioned whether Operation Twist would have any positive effects on the broader economy as long-term interest rates have already hovered below pre-2008 crisis levels.