Fed sees signs recession may easing

The Federal Reserve decided Wednesday to play chicken with Treasury bond traders: Despite rising yields on long-term government bonds in recent weeks, the central bank opted not to expand its program of buying the securities to rein in interest rates.

Traders reacted by dumping Treasuries, driving their yields sharply higher. The 10-year T-note yield, a benchmark for mortgage rates, surged to 3.09%, up from 3% on Tuesday and the highest since Nov. 25.

Earlier Wednesday, the Treasury announced plans to boost sales of 30-year bonds this year, as Uncle Sam’s borrowing reaches unprecedented levels. The government also sold $26 billion in new seven-year notes at a yield of 2.63%, slightly above expectations.

Hiding out in “safe” government bonds, the smart move in the second half of 2008, has been a money-loser for many investors this year.


With the supply of Treasuries ballooning -- and yields moving higher in recent weeks -- the bond market had been hoping that the Fed would pledge to expand its purchases of Treasuries from the $300-billion target it set in February.

But Chairman Ben S. Bernanke and peers decided to take their chances in a stare-down with bond traders.

In its post-meeting statement Wednesday, the Fed’s comment on its Treasury-purchase program was that it would “continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets.”

Translation: The Fed isn’t yet worried about rising yields.


That makes sense, on one level: Long-term Treasury yields are up in part because investors are feeling better about the economy and are more willing to buy stocks, corporate bonds and other riskier assets.

“The demand for risk-free assets is ebbing while the supply of risk-free government paper is increasing rapidly. Hence, higher Treasury yields,” said Michael Darda, economist at MKM Partners.

Corporate bond yields, he noted, have been dropping even as Treasury yields have risen. And 30-year mortgage rates have been treading water around 4.8% for four weeks.

With that backdrop, the Fed can afford to keep some ammunition in reserve, said Tony Crescenzi, bond market strategist at Miller Tabak & Co.

“Only if the anchor, Treasuries, lifts so much that it causes the boat -- mortgage rates and corporate and other fixed-income rates in the private credit markets -- to drift will the Fed have to expand its program” of buying government bonds, Crescenzi said in a note to clients.