Fed Adds Fuel to Big Rally in Bonds

Yields on Treasury securities fell across the board Tuesday, pushing rates on two-year notes to historic lows, as the bond market reacted enthusiastically to the latest Federal Reserve credit-easing move.

Traders said this year’s tremendous bond rally may not be over, because the Fed signaled it may be prepared to cut its benchmark rate further.

Citing deteriorating business conditions, the Fed delivered its 10th monetary easing of the year and the third half-point cut since the devastating attacks on the World Trade Center and the Pentagon.

The Fed cut its target for the federal funds rate, the overnight loan rate among banks, to 2% from 2.5%.

“It was aggressive. They kept the easing bias and they’re giving no hints that they’re nearing the end of the easing cycle,” said Dominic Konstam, interest rate strategist at Credit Suisse First Boston.

The yield on the benchmark 10-year Treasury note fell to 4.25% from Monday’s close of 4.30%. The yield on the two-year note fell to 2.33% from 2.44% Monday.

Strategists said the rally in shorter-term securities would have been even bigger had it not been for a Treasury auction of $16 billion in new five-year notes about an hour before the Fed’s decision. The auction sapped some demand for shorter-term issues. The five-year notes were sold at a yield of 3.62%.

Longer-term bond yields plunged last week after the Treasury said it would stop issuing 30-year bonds. The announcement triggered a rush by investors to lock in yields.

The Fed doesn’t have direct control over long term rates, but its moves with short-term rates can influence trends in longer-term issues.

The Fed’s statement Tuesday, which highlighted worsening business conditions both in the United States and abroad, left the door open for further rate cuts.

“The bottom line is they’re going to ease again,” said Anthony Karydakis, senior financial economist at Banc One Capital Markets.

A Reuters poll conducted after the Fed’s rate decision showed the market agrees, with 23 of 24 U.S. primary dealers predicting a quarter-point rate cut at the Fed’s next policy meeting, set for Dec. 11.

With the fed funds rate at its lowest level since 1961, economists say the Fed may soon run out of room to loosen monetary policy further. Even so, the Reuters poll showed 12 dealers expect the federal funds rate will be at 1.5% by the middle of next year.