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Fed fallout: Gold at new high but T-bond rally slows

September 22, 2010 |  4:24 pm

Gold hit a new high and the dollar sank further Wednesday as more investors and traders bet the Federal Reserve will make good on its promise to drive up inflation.

But the Treasury bond market reconsidered after rallying early in the session. Yields ended mixed.

The stock market took a back seat to the action in other markets: Most stock indexes were modestly lower for a second day, with the Standard & Poor’s 500 index losing 0.5% to 1,134.28.

Fed policymakers' post-meeting statement Tuesday signaled that they’re worried that inflation has fallen too low, putting the economy at risk of deflation. The wording on inflation was viewed as setting the stage for another big move by policymakers to pump money into the financial system -- probably by aggressively boosting the Fed’s purchases of Treasury securities.

Fedfacade The Fed didn’t commit to that, but many economists now think the central bank will act by the end of this year.

The Fed’s statement was a boon for gold, the classic inflation hedge -- particularly given that the metal already had rallied sharply this year. The Fed now may be the gold market’s best friend as the price knocks on the door of $1,300 an ounce.

The metal jumped to $1,289.40 in electronic futures trading Tuesday and rallied as high as $1,294.50 on Wednesday before ending the regular futures session at $1,290.20, a record close. The price is up 17.8% year to date.

In currency trading, the euro surged to five-month high of $1.341 from $1.325 on Tuesday. The dollar also slid against the Australian dollar, the Swiss franc and the South Korea won, among others.

Still, this is no dollar crisis: The buck remains well above its low point of early-2008 as measured by the DXY index, which tracks the dollar’s value against six other major currencies. The index fell 0.8% to 79.83 Wednesday, but would have to slump another 10.7% to drop below the multi-decade low of 71.33 reached April 22, 2008.

As for Treasury bonds, yields ended the day mixed as some investors and traders sold after the market rallied early in the session. The 10-year T-note yield, a benchmark for mortgage rates, fell as low as 2.50% -- nearing the 19-month low of 2.47% set Aug. 31 -- but then inched back up to end the day at 2.54%. That still was down from 2.59% on Tuesday and 2.70% on Monday.

The three-year T-note yield rose to 0.68% from a record low of 0.66% on Tuesday.

The question for bond investors is, what’s your time horizon? In theory, a major new Fed commitment to buy Treasuries would push bond yields lower in the short run. But longer term, if the central bank succeeds in driving inflation up from what is now an annual rate of less than 1% (as measured by the “core” consumer price index), fixed-rate bonds at low yields could turn out to be lousy investments.

-- Tom Petruno

Photo: The Federal Reserve building in Washington.