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Long-term interest rates plunge on hopes for new Fed stimulus [Updated]

September 2, 2011 | 11:40 am

Long-term Treasury bond yields tumbled Friday as investors bet that the grim employment picture will force the Federal Reserve to launch a new bond-buying economic stimulus program.

The 10-year T-note yield, a benchmark for mortgages and other long-term interest rates, plunged to 2.01% by about 11:40 a.m. PDT, down from 2.13% on Thursday.

If the yield closes at current levels it will mark a new generational low, falling below the previous low of 2.06% reached in mid-August. [Updated at 2:40 p.m.: The 10-year yield ended at 1.99%, the lowest since at least 1950.]

Shorter-term Treasury yields, however, were slightly higher. The two-year T-note edged up to 0.20% from 0.18% on Thursday.

The reason for the split performance: With short-term rates already near zero, Wall Street now expects the Fed to launch a Treasury-bond-buying program specifically aimed at pulling down longer-term interest rates.

The Fed tried a similar program in the early 1960s. It was dubbed “Operation Twist” because the goal was to twist the so-called yield curve, bringing longer-term rates down while holding shorter-term rates steady or allowing them to rise modestly.

Rather than print new money to finance purchases of longer-term bonds, the Fed could sell some of its shorter-term Treasury holdings and reinvest the proceeds in longer-term issues, such as the 10-year T-note. Fed Chairman Ben S. Bernanke has hinted in recent months that the central bank could turn to that option if the economy needed more help. The Fed owns $2.6 trillion in Treasury and mortgage securities in all.

The next Fed stimulus plan “would most likely come in the form of an ‘Operation Twist’-like approach, whereby the Fed sells shorter-maturity assets to purchase longer-maturity assets,” economists at Deutsche Bank Securities said in a report Friday. “The size of the Fed’s balance sheet will remain unchanged, but presumably longer-term interest rates would fall.”

If the result is to pull mortgage rates down further, that could allow more homeowners to refinance their loans -- assuming that they have equity left in their homes.

The 30-year T-bond yield also was sharply lower Friday, falling to a two-year low of 3.32% from 3.50% on Thursday.

Bank of America Merrill Lynch economists said that even if the Fed resorted to selling shorter-term Treasuries, it was unlikely to cause a “significant” rise in yields on those securities because demand remains robust from other investors, including money market funds and foreign central banks.

And if the stock market keeps tumbling, more spooked equity investors are likely to join the rush back to Treasuries. The Dow Jones industrials were down 251 points, or 2.2%, to 11,241 at about 11:40 a.m. PDT as recession fears flared anew.


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Photo: The Federal Reserve Building in Washington. Credit: Karen Bleier / AFP / Getty Images