US Treasuries rally on safety bid, talk of Fed purchases

(Updates prices, comments after Bernanke remarks)

By Ellen Freilich

NEW YORK, Dec 1 (Reuters) - Long-term U.S. government bond yields fell to their lowest levels in more than five decades on Monday as sharp stock market losses and talk that the Federal Reserve could buy government and agency bonds spurred another big rally in U.S. Treasuries.

U.S. Treasuries prices rose early as U.S. stocks fell following routs in Asian and European equity markets, revived investors' appetite for safe-haven U.S. government debt.

A survey by the Institute for Supply Management showed U.S. manufacturing output fell in November to its weakest level since the 1981-1982 recession, fanning fears of a long economic downturn. An October drop in construction spending and a technical declaration that the U.S. economy is, indeed, officially in recession added to economic jitters..

The reports supported expectations that the Fed would cut its benchmark overnight lending rate by about half a percentage point, to 0.50 percent, this month. That would be the lowest on record dating to mid-1954.

Fed Chairman Ben Bernanke said that the Fed could employ methods besides cutting short-term interest rates to keep the financial system liquid, which caused longer-dated Treasury securities to extend their rally in afternoon trading.

Benchmark 10-year Treasury notes US10YT=RR, which were up 24/32 before Bernanke spoke, nearly tripled their gains by the time Bernanke finished delivering his prepared remarks to the Greater Austin Chamber of Commerce in Austin, Texas.

"The bond market was on fire after Bernanke said that one monetary policy option to get interest rates closer to zero is to out-and-out buy longer-term Treasuries and agencies," said Chris Rupkey, chief financial economist at Bank of Tokyo/Mitsubishi. "The Fed hasn't bought anything yet, but just the idea that it could buy Treasuries set off a huge rally."

In late trade, 10-year Treasury yields, which move inversely to price, had fallen to 2.71 percent, from 2.85 percent before Bernanke spoke and from 2.92 percent on Friday.

Bernanke urged decisive action to protect the U.S. economy and said the Fed could directly buy longer-term securities issued by the U.S. Treasury or government-sponsored agencies in order to influence yields and stimulate demand.

The Fed is widely expected to lower rates by a half percentage point to 0.50 percent at its next scheduled meeting, on Dec. 15-16, and to use so-called quantitative measures to pump up financial market liquidity and curb economic weakness.

In addition, a House Democratic aide said that Democrats in the U.S. House of Representatives likely will seek passage next month of an economic stimulus bill costing about $500 billion, a smaller package than some economists have recommended.

Earlier on Monday, House Speaker Nancy Pelosi told reporters she hoped Congress would have an economic stimulus bill ready for Obama to sign when he takes office on Jan. 20. She did not provide details. (Editing by Tom Hals)