Treasurys Rally on Fed's Long-Term Purchase Plan

Treasury debt prices soared Wednesday, prompting the biggest one-day drop in benchmark yields since 1987, after the Federal Reserve made a surprise announcement that it would buy long-term Treasuries.

In a statement released at the end of its two-day policy meeting, the Fed said it would buy up to $300 billion worth of longer-term U.S. government debt over the next six months and expand purchases of mortgage-related debt to help ease credit market conditions.

Bond prices soared on the news. Benchmark 10-year note prices rose four full points while their yields, which move inversely, had the biggest one-day drop since October 20, 1987, the day after the 1987 stock market crash.

"The Fed had been looking for a new way to make a big headline effect on the markets, and they found it,'' said Chris Rupkey, chief financial economist at Bank of Tokyo/Mitsubishi UFJ in New York. "The outlook for economic recovery in the second half of the year is on much firmer ground today.''

The Fed also said it would buy up to $1.2 trillion of agency mortgage-backed securities, up from the prior plan to buy $500 billion of those securties by June, or nearly all the mortgage-backed securities issuance each year.

"If this doesn't cut mortgage rates to 4.5 percent and jump start the housing market, what will?'' Rupkey said.

The reaction in mortgage rates was immediate, with Quicken Loans in Livonia, Michigan, saying that 30-year mortgage rates dropped by as much as 0.375 percentage point to 5 percent after the Fed's announcement.

The market's reaction to the news was dramatic because bond investors had largely concluded the Fed was not about to buy longer-term Treasuries in the immediate future, analysts said.

"In Congressional testimony, Fed Chairman Ben Bernanke had suggested that for the time being the Fed was going to pursue its efforts to stir activity in the private credit markets and would only consider the purchase of Treasury securities at some future point,'' said Michael Moran, chief economist at Daiwa Securities America in New York.

"Thus, a lot of people believed that the purchase of longer-term Treasury securities by the Fed was not under serious consideration for the near term,'' he said.

Rupkey said the Fed's move would go a long way toward instilling confidence in investors who thought central bank policy-makers were "out of ammunition'' after they cut short rates to zero.

While the economy is "not yet out of the woods, the Fed is working overtime'' to thaw the credit freeze, Rupkey said.

"If their decision today keeps stocks off of their recent lows, the odds are good that the recession could be over in months rather than years,'' he said.

Stocks rallied after the Fed announcement.

In its statement, the central bank's policy panel also said it had decided to hold its target for overnight interest rates in a range of zero to 0.25 percent—the level reached in December—and repeated that borrowing costs would likely stay unusually low for some time.

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