TREASURIES-Yields drop as Fed surprises investors, maintains purchases
* Yields fall to lowest in over a month
* Fed maintains $85 billion bond a month purchases
* Fed surprises investors who had positioned for tapering
* Ten-year note yields fall to 2.70 percent
By Karen Brettell
NEW YORK, Sept 18 (Reuters) - U.S. Treasuries yields dropped on Wednesday to their lowest in over a month after the Federal Reserve said it would maintain its bond purchases at $85 billion a month, surprising investors who had expected it would reduce the size of its buying program.
Citing strains in the economy from tight fiscal policy and higher mortgage rates, the Fed decided against the tapering of asset purchases that investors had all but priced into stock and bond markets.
The statement caused a dramatic turnaround in Treasuries prices, which had weakened heading into the announcement.
"Obviously this was very surprising. There is no question that we were being set up for Fed tapering," said Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York.
Benchmark 10-year notes were last up 1-12/32 in price to yield 2.68 percent, down from 2.86 percent before the statement and the lowest since Aug. 13.
Five-year notes gained 29/32 in price to yield 1.42 percent, down from 1.63 percent before the statement.
Thirty-year bonds rose 1-14/32 in price to yield 3.75 percent, down from 3.84 percent before the statement.
Weakening economic indicators in recent weeks had reduced expectations over the size of any potential pullback in bond purchases, though most expected that the Fed would make at least a small cut.
Some analysts and investors interpreted Wednesday's statement as an indicator that the Fed is also nervous over the effect of rising bond yields on the recovering housing market.
"It's pretty clear that the Fed feels that higher interest rates along with fiscal policy constraints are having a negative impact on the economy so they want to lower real yields and they sent that signal to the markets," said Michael Materasso, senior vice president and co-chair of the Franklin Templeton fixed income policy committee.
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