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Interest rates hit new lows as market bets on Fed 'rescue'

October 6, 2010 |  1:38 pm

With U.S. Treasury bond yields crashing to new lows Wednesday, it looks like many bond buyers are making a simple bet: They’ll be able to sell to the Federal Reserve at even lower yields later this year.

In other words, Treasuries now are sort of a game of hot potato, with the Fed expected to be the final catcher -- and holder.

And as Fed Chairman Ben S. Bernanke has pointed out in so many words, the central bank’s resources are limitless; it controls the money printing press.

Amid a batch of grim economic headlines, the yield on the 10-year T-note fell to as low as 2.38%, down from 2.47% on Tuesday and the lowest since January 2009. Three weeks ago the yield was 2.76%.

Expect mortgage rates to keep dropping; they take their cues from Treasury yields.

The bond market seems more convinced than ever that the Fed next month will announce a major “quantitative easing” program, or QE -- meaning massive purchases of government bonds, with the goal of driving market interest rates in general down further to help the economy.

Fedbuild The Bank of Japan announced its own QE program Tuesday. Fed officials in recent days have been telegraphing that they were leaning toward a big QE push. But some U.S. bond investors and traders apparently needed more evidence that QE was likely. They got it Wednesday, after ADP Employer Services’ monthly estimate of private-sector job trends showed a net decline of 39,000 positions in September.

If Friday’s government report on the labor market also is weak, it should further boost QE expectations.

There were more reasons Wednesday to bet on QE. The International Monetary Fund cut its estimate of U.S. economic growth in 2011 to 2.3% from a previous estimate of 2.9%, and basically blessed the idea of the Fed taking stronger action to support growth.

And Goldman Sachs economists used the R-word, warning that the U.S. could fall back into recession in the next six to nine months. Goldman has been a forceful advocate for QE: In August the firm predicted that the Fed could commit to buying upwards of $1 trillion of Treasuries for its own account to try to rescue the economy.

John Spinello, bond strategist at Jefferies & Co. in New York, cautioned that many buyers of Treasuries at these yields were in it only for a trade based on QE hopes: “They’re saying, ‘I don’t need them, but I’m going to buy them for the next month,” expecting to unload the bonds at higher prices (and lower yields) assuming the Fed starts ramping up its purchases.

“It’s a complete front-running of the event,” Spinello said.

But he said there also were legitimate investors in the market -- mainly Japanese investors, to whom a 2.38% yield looks downright juicy compared with the 0.84% yield on Japanese 10-year government bonds.

Meanwhile, the markets’ expectations that the Fed will flood the financial system with more money continue to sink the dollar, in turn driving more investors into hard assets like gold. The metal rose $7.50 to a record $1,346.40 an ounce Wednesday, even as some veteran analysts warned that gold was increasingly vulnerable to a pullback.

The stock market’s big Tuesday rally ran out of steam Wednesday, with most stocks modestly lower, although the Dow industrials were up slightly.

Wall Street’s mantra lately seems to be the time-honored one: Don’t fight the Fed.

-- Tom Petruno

Photo: The Fed's headquarters in Washington. Credit: Jim Young / Reuters

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