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Long-term interest rates dive on Fed plan to buy T-bonds

March 18, 2009 | 12:02 pm

The Federal Reserve opted for shock treatment today in its continuing efforts to ease the credit crunch: The central bank said it would buy up to $300 billion of longer-term U.S. Treasury securities for its own portfolio over the next six months.

The news instantly sent Treasury yields plummeting: The 10-year T-note yield, a benchmark for mortgage rates, dived to 2.56% by about noon PDT, from 3% on Tuesday.

The 30-year T-bond yield plunged to 3.58% from 3.83% on Tuesday. The two-year T-note dropped to 0.81% from 1.03%.

The Fed’s surprise decision, announced after its regular meeting, also triggered a jump in stock prices. The Dow Jones industrial average, which had been modestly in the red for the session, was up 155 points, or 2.1%, to 7,551 at about noon PDT, the sixth advance in seven sessions.

But the Fed's move has sent the dollar plummeting and gold soaring, on fears that policymakers are pulling out all the stops to boost the economy -- even if that stokes inflation.

Fedhq The Fed has said in recent months that it was considering buying Treasury bonds, but many bond investors were doubtful the central bank was ready to make that move. The Treasury market was clearly caught by surprise today -- which may be what the Fed was hoping to achieve.

"The Fed has been looking for a new way to make a big headline announcement effect on the markets, and they have found it," said Chris Rupkey, an economist at Bank of Tokyo-Mitsubishi.

By purchasing Treasuries for its own portfolio, the Fed becomes a source of demand for the bonds at a time of record Treasury borrowing to rescue the economy and financial system. Higher demand could, at a minimum, keep a lid on Treasury yields, which in turn could influence other long-term interest rates -- including mortgage rates.

The Fed made another commitment today to pull mortgage rates lower by saying it would buy an additional $750 billion of mortgage-backed securities this year, raising its total purchase commitment for those securities to $1.25 trillion.

A continuing decline in mortgage rates in recent weeks already has fueled a fresh boom in refinancings.

The Mortgage Bankers Assn. said today that its index of refinancing activity nationwide jumped 30% last week from the previous week, to the highest level since mid-January.

As a share of total mortgage activity, refis accounted for 73% of loan applications last week, up from 68% the previous week. Purchase loans accounted for the rest.

The average 30-year loan rate fell to 4.89% in the bankers’ weekly survey, down from 4.96% a week earlier and matching the recent low reached in January. That rate is for 80% loan-to-value mortgages, with an average of 1.23 points, the group said.

Mortgage finance giant Fannie Mae said its refinancing volume soared to $41 billion in February, nearly three times the level of January.

The company, now under U.S. control, said it expected refis to continue to increase under the Obama administration’s mortgage-help program, Making Home Affordable. The plan will allow homeowners to refinance loans held by Fannie Mae or Freddie Mac for a maximum loan-to-value ratio of 105% -- in other words, for 5% more than their home is worth.

-- Tom Petruno

Photo: The Fed's headquarters in Washington. Credit: Karen Bleier / AFP/Getty Images