Fed's near-zero target startles markets

The Fed said it would "establish a target range for the federal funds rate of 0 to 0.25%", down from its previous target of 1%. It also said it would continue to buy up agency debt and mortgage-backed securities, and added it might begin purchasing longer-term Treasury securities. "Weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time," the Fed's open market committee said in a statement.

The Standard & Poor's 500 index was lifted by the news, rising 5.1% to close at 913.18. At 10:00am GMT today, US Treasury bill yields had dropped to new lows across the curve, with the drop particularly steep at the long end: 10-year yields were at 2.239, down from 3.65 a month ago, and 30-year yields hit 2.723 from 4.18 a month ago.

With the promise of continuing buybacks, agency bond yields also fell - Fannie Mae two-year bonds fell to 1.471% from 1.705% yesterday, and Freddie Mac two-year bonds fell to 1.523% from 1.706%.

The currency markets were relatively unaffected, with the euro and sterling both rising slightly against the dollar - the euro was up 2c to $1.404 and sterling rose 2p to $1.55.

Interbank borrowing rates fell around the world, most sharply in the dollar market. Overnight dollar Libor fell to 0.1325% from 0.1594%, and three-month dollar Libor also fell to 1.5775% from 1.8475%. Sterling overnight Libor was unchanged at 2%, but the three-month rate fell to 3.0575% from 3.1075%. And the euro rates fell slightly -down to 2.195% from 2.204% overnight, and from 3.2025% to 3.145% at three months.

The Ted spread, a measure of perceived risk in interbank lending, derived from the difference between the three-month US Treasury yield and the three-month dollar Libor interbank rate, also fell sharply to 1.54 from 1.82 before the cut.

See also: New York Fed buys AIG assets at half price
Interbank lending rates continue to fall
Interbank lending benefits from rates cuts
Sterling Libor eases after rate cuts
Central banks promise unlimited dollar lending

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