December 12, 2012 / 9:26 PM / in 5 years

RPT-TREASURIES-Prices drop as Fed announces new bond-buying program

* Fed announces $45 bln a month of Treasury buying
    * Fed adopts numerical thresholds for policy
    * 30-year bonds underperform, yields at month-high

    By Karen Brettell and Luciana Lopez
    NEW YORK, Dec 12 (Reuters) - Treasuries prices fell on
Wednesday, with 30-year bonds falling particularly sharply,
after the Federal Reserve's announced a new bond-buying program
that shifts more of its purchases to the five-year sector.
     The new easing program fueled expectations of a boost to
the economy that will help riskier assets such as stocks.
    The Federal Reserve committed to monthly purchases of $45
billion in Treasuries on top of the $40 billion per month in
mortgage-backed bonds it started buying in September. 
    It will expand purchases to five-year notes from the current
seven-, 10- and 30-year Treasuries.
    "They are buying less in seven-years through bonds, and
buying some of the five-years, which they weren't doing
before. People also think that when the Fed does QE that the
economy is going to get better, so it's a steeper yield curve,"
said Ira Jersey, an interest rate strategist at Credit Suisse in
New York.
    Under its Operation Twist program, the Fed has been selling
shorter-dated Treasuries and using the proceeds to buy
longer-dated debt. The program is set to expire at the end of
December, and analysts say the Fed has little to no
shorter-dated debt to sell. 
    Thirty-year bonds dropped 1-06/32 in price to
yield 2.901 percent, up from 2.84 percent late on Tuesday.
    The yield gap between five-year notes and 30-year bonds also
expanded to 225 basis points from 221 late on Tuesday to the
widest since October.
    The new purchases will extend the average duration of the
bonds the Fed holds on its balance sheet, though that is likely
to fall back as many of those bonds are repaid.
    "The new purchases will have an average duration of nine
years, which is longer than the average eight years of the bonds
that the Fed currently holds," said Michael Schumacher, head of
global rates strategy at UBS in Stamford, Connecticut.
    "Over the coming year, as bonds the Fed holds roll down, the
duration is likely to fall back to below eight years," he said.
    The Fed also took the unprecedented step of saying it would
keep interest rates near zero until the jobless rate falls to
6.5 percent, well below its current level, so long as inflation
and inflation expectations were contained. 
    The shift to economic thresholds surprised some investors
and increased the possibility that rates could increase from
near zero before the previous guidance of mid-2015.
    "The bigger surprise for the bond market was the forward
guidance, which changed from a calendar-based one to one based
on economic thresholds," said Mike Lorizio, head of Treasuries
trading at Manulife Asset Management in Boston.
    "Many in the market had thought this was a Q1 event, but
with the fiscal cliff, they might have decided it was better to
do it now," he said.
    Five-year notes fell 03/32 in price to yield
0.654 percent, from around 0.636 percent late on Tuesday.
Benchmark 10-year notes dropped 14/32 to yield 1.704
    Treasuries had edged slightly higher earlier on Wednesday
following strong demand for an auction of $21 billion of 10-year
notes. The notes sold at a high yield of 1.65 percent, around 2
basis points lower than where the notes were trading before the
    The Treasury on Thursday will sell $13 billion of 30-year
bonds, and next week it will auction two-, five- and seven-year
notes along with five-year Treasury inflation-protected
securities. The Treasury on Tuesday sold $32 billion of
three-year notes.
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