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Treasury bond yields slide on Fed's new caution

June 23, 2010 | 12:52 pm

Federal Reserve policymakers sounded more worried about the U.S. economy in their post-meeting statement on Wednesday, and that has triggered a new rush into the relative safety of Treasury bonds.

The 10-year Treasury note yield has tumbled to 3.11% from 3.16% on Tuesday, and now is the lowest since April 2009. It has plunged from nearly 4% two months ago.

The Fed’s concerns helped the Treasury market overcome some disappointment after the government’s sale of $38 billion in new five-year notes saw weaker-than-expected demand.

Fedfacade2 Not surprisingly, investors also are more comfortable locking in Treasury yields because the Fed’s cautious tone suggests it will be a long time before the central bank begins to tighten credit by raising short-term rates. The Fed once again said it was likely to keep its benchmark rate at “exceptionally low levels . . . for an extended period.” That rate now is between zero and 0.25%.

Although policymakers in their statement said that “the economic recovery is proceeding,” they sounded more concerned about the health of the financial system than they did in their April meeting statement.

The April statement had said that “financial market conditions remain supportive of economic growth.”

This time, the Fed warned that “financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad” -- an obvious reference to Europe’s government debt crisis, which also has infected the continent’s banking system.

The Fed also acknowledged that lending by U.S. commercial banks "has continued to contract in recent months," which could mean that many banks remain wary about lending or that potential borrowers aren't interested in taking on new debt -- or both. Either way, falling loan volume is a sign of a still-struggling economy. 

While the Treasury bond market is the big winner today thanks to the Fed’s new caution, the stock market has mostly been treading water after Tuesday's sell-off. The Dow Jones industrial average was up 0.3% to 10,326 with about 10 minutes to go in the trading session. Broader indexes also were little changed.

Falling Treasury yields should help pull mortgage rates down further, but as I noted in this earlier post it isn’t clear that lower home loan rates can do much for housing demand in the near term.

--Tom Petruno

Photo: The Fed's headquarters in Washington.

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