* Fed expected to buy $45 bln per month of Treasuries
* Shorter-dated debt now being sold under Operation Twist
* Impact of anticipated buying program priced into Treasuries
By Chris Reese
NEW YORK, Dec 7 (Reuters) - The Federal Reserve's massive bond-buying effort known as "Operation Twist" is coming to a close. But the Fed's dominance of the Treasury market is set to continue, and it is that expectation that is most responsible for lower yields.
U.S. bond yields have steadily been driven lower thanks to the market presence of the Fed - which could intensify after the central bank unveils its next round of bond-buying next week.
When the new program of Fed purchases kicks off, the downward pressure on yields could intensify as the central bank takes up a bigger share of the available supply.
The central bank is expected to announce after its policy meeting on Tuesday and Wednesday it intends to buy longer-dated Treasury debt beginning in January, in an effort to support the economy by keeping interest rates on loans as low as possible.
These expectations have lifted Treasury debt prices and weighed heavily on bond yields already near historic lows, according to analysts, with the benchmark 10-year Treasury note yield trading at 1.61 percent on Friday, not far off the record low of 1.38 percent touched in late July.
It's not just the buying that is taking down yields, but the belief that more is in the offing. It may be taking as much as one percentage point off of the benchmark 10-year yield, said Zach Pandl, strategist at Columbia Management in Minneapolis.
Quantitative easing "is keeping rates lower than they otherwise would be," Pandl said. "QE affects interest rates through the expected stock of purchases, rather than the ongoing flow of purchases, and today that expected stock of purchases is very high."
That does make expectations for the next purchase program important. Analysts interviewed Friday believe the Fed will probably elect to buy about $45 billion per month in long-dated securities, same as the current "Operation Twist" buying, which also involves the Fed selling short-dated debt.
That's going to tighten supply further in long-dated Treasuries. The Fed's purchases of U.S. government debt next year will exceed the level of new longer-dated debt issuance from the Treasury, analysts said.
"They are basically going to be pushing up to becoming the major holder in every segment of the yield curve," said Robert Tipp, chief investment strategist with Prudential Fixed Income in Newark, New Jersey.
Analysts said the central bank in some cases has already bumped up against its self-imposed threshold of owning 70 percent of any particular maturity. "They now hold about a third of the six-year or longer Treasury market," he added.
The Fed already bought $2.3 trillion of mortgage and government debt in two rounds of quantitative easing, known as QE1 and QE2, since 2008. Under an open-ended program announced in September and known as QE3, the Fed is buying $40 billion per month of mortgage-backed securities.
The central bank said in September that Operation Twist would continue through December and if the jobs market did not "improve substantially" it will "undertake additional asset purchases and employ its other policy tools as appropriate."
Last year, the Fed outpaced China as the single largest holder of U.S. government debt. Fed data on Thursday showed the central bank owned over $1.6 trillion of U.S. Treasury securities. The Treasury estimates the size of U.S. total public debt outstanding at about $16.3 trillion.
Fed buying is not expected to create an imminent supply crunch however, said Scott Sherman, interest rate strategist at Credit Suisse in New York.
"When I calculate the total amount that the Fed will allow itself to buy in issues, which is 70 percent, there is still over $300 billion in purchasable supply out there," he said. "At some point it will come to a head, but I don't know if that is three months from now or three years from now."