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U.S. Bonds rise after Fed cuts rates a half-point to 5 percent

NEW YORK —U.S. Treasuries rose after the Federal Reserve lowered interest rates to 5 percent and signaled another rate cut could come as early as next month -- before the central bank is scheduled to meet on May 15.

"The Fed looks as though it's ready to do another inter-meeting move," said Michael Materasso, who oversees $7.5 billion at Fiduciary Trust Co. International. "It's going to take longer for the economy to turn around, and the Fed is going to have to keep" cutting rates, which is "positive for bonds," he said.

In midafternoon trading, the benchmark 10-year U.S. Treasury note rose 11/32, or $3.44 cents per $1,000 face amount, to a price of 101 26/32. Its yield fell 4 basis points to 4.77 percent. The most-active 30-year bond rose 12/32 to 101 20/32. Its yield fell 3 basis points to 5.26 percent.

Policy-makers cited falling stocks, a slump in U.S. manufacturing and "weakness in global economic conditions" as the reasons for their decision to lower rates by 50 basis points. "Persistent pressures on profit margins are restraining investment spending and, through declines in equity wealth, consumption," the Fed said in a statement released with its rate-cut decision. "In these circumstances, when the economic situation could be evolving rapidly, the Federal Reserve will need to monitor developments closely."

It's this last comment that suggests Fed officials are prepared to cut rates at their next meeting on May 15, or even before then, if need be, said analysts.

"This reads like they are more scared than they have been willing to admit, and that they are ready to cut rates further --maybe soon," said Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd. in Valhalla, New York, which is looking for rates to fall to 4 percent by summer.

Traders had priced in a 100 percent probability of a 50 basis point cut, and a 70 percent chance of a 75 basis point cut, according to the fed funds futures contract for March. The contract's implied yield jumped 2.5 basis points to 5.29 percent, and had been as low as 5.19 percent on Feb. 26 and 27 when calls for an inter-meeting rate cut, which never came to pass, reached an almost fevered pitch.

Is a 50 basis point cut "as good as 75? Absolutely not," Wayne Angell, chief economist at Bear Stearns & Co, and a former Fed governor, said on Bloomberg Television. "It was a mistake, and they should not have made this mistake. The economy will continue to weaken."

The three major U.S. stock measures fell after the Fed's decision was announced, prompting some investors to shift money to government debt. The Nasdaq Composite Index led the decline, falling almost 3 percent, while the Dow Jones Industrial Average lost 1.4 percent of its value.

For the second year, government debt has outperformed the three major U.S. stock measures, led by the 30-year bond. Year-to-date, the bond has returned 4.1 percent, while the 10-year note has climbed 3.7 percent. In contrast, the Nasdaq Composite Index has lost 23 percent of its value, while the Dow Jones Industrial Average has dropped 9 percent.

Lowering rates by 75 basis points has not been done since the Fed started targeting interest rates in 1983, and the last 75 basis-point move in any direction came on Nov. 15, 1994—when the Fed raised rates from 4.75 percent to 5.5 percent.

But even as some analysts called for a 75 basis-point cut, recent reports including consumer confidence, steel production, auto sales and home construction, suggested the economy wasn't deteriorating enough to warrant such a move, analysts said.

Since Nov. 7, the yield on the current two-year note, among the securities most sensitive to changes in Fed policy, has plunged 176 basis points as investors bid up Treasury prices in anticipation of interest-rate cuts. Its yield is now 78 basis points below the Fed's current target of 5 percent, meaning that Treasuries need to see that the economy is truly faltering to justify their low yields, analysts said.

"Once you perceive the Fed is done" cutting rates, "why would you want to own bonds at these crazy levels?" said George Adell, a trader at Philadelphia-based Starboard Capital Markets. "They may go crazier, but who wants to be left holding the bag? If you're really looking for value, Treasuries don't have it."

Year-to-date, policymakers have lowered rates 1.5 percentage point, to 5 percent, in three separate 50 basis point moves, on Jan. 3 and Jan. 31, and today. The Fed had raised rates six times, by a total 1.75 percentage points, from June 1999 to May 2000 in a bid to slow economic growth and rein in faster inflation.