March 18 (Bloomberg) -- Treasury 10-year note yields fell the most since 1962 as the Federal Reserve surprised investors with plans to purchase as much as $300 billion in government debt to drive consumer borrowing costs lower and lift the economy from recession.

The difference between two- and 10-year Treasury note yields narrowed 25 basis points to 1.72 percentage points, the most in at least 25 years, after the central bank said the purchases will be concentrated among those securities. The Fed is expanding the debt purchase portion of its quantitative easing policy, which already includes agency and mortgage debt, to about $1.75 trillion in securities.

“This is shock and awe,” said Steve Rodosky, the head of Treasury and derivatives trading at Newport Beach, California- based Pacific Investment Management Co., which runs the world’s largest bond fund. “The shoot first, assess later approach, with the economy teetering as it is, is the correct method.”

The yield on the benchmark 10-year note tumbled 47 basis points, or 0.47 percentage point, to 2.54 percent at 6:20 p.m. in New York, according to BGCantor Market Data. It fell 54 basis points in January 1962. The price of the 2.75 percent security due in February 2019 surged 4 1/32, or $40.31 per $1,000 face amount, to 101 26/32.

The 30-year bond’s yield tumbled 28 basis points to 3.55 percent. Yields decreased 21 basis points to 0.83 percent on two- year notes.

Treasuries had lost investors 3.4 percent since December, on course for the worst three-month period since the third quarter of 1980, when they fell 5.06 percent, according to a Merrill Lynch & Co. index. Investor concern about rising supplies of debt and gains in equities depressed prices, pushing yields up from record lows in the fourth quarter.

Consumer Rates

Investors have shunned debt backed by consumer loans as unemployment has climbed in the worst financial crisis since the Great Depression. Sales of the bonds plunged 40 percent last year to $106 billion, according to data compiled by Bloomberg, choking off funding to lenders. About $2.3 billion of debt backed by auto loans has been sold this year, compared with more than $9.6 billion in the same period of 2008, according to data from JPMorgan Chase & Co.

Central bankers and Treasury haven’t been able to meet Fed Chairman Ben S. Bernanke’s goal of reducing consumer interest rates along with the borrowing costs paid by banks. The difference between rates on 30-year fixed mortgages and 10-year Treasuries was 2.1 percentage points as of yesterday, Bloomberg data show. That’s up from an average of 1.75 percentage points in the decade before the subprime mortgage market collapsed.

‘Fed’s Willingness’

Bernanke trimmed the target rate for overnight loans between banks to a range of zero to 0.25 percent at the Dec. 16 policy meeting to help unfreeze credit markets.

“This demonstrates the Fed’s willingness to address this financial crisis,” said David Glocke, who manages $65 billion of Treasuries at Vanguard Group Inc. in Valley Forge, Pennsylvania. “It helps to reduce rates all over.”

The extra yield relative to benchmark interest rates that investors demand to own debt backed by consumer loans has soared amid concern that defaults will climb. Top-rated bonds backed by auto loans are trading at about 300 basis points more than the one-month London interbank offered rate compared with 65 basis points in January 2008, JPMorgan data show. One-month Libor, a borrowing benchmark, is currently 0.56 percent.

TALF Expansion

The central bank also said it will consider expanding the Term Asset-Backed Securities Loan Facility to include “other financial assets,” the central bank’s policy statement said. The Fed added that it will “increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.

The Fed will buy $750 billion in mortgage-backed securities on top of the already-announced $500 billion program.

Treasury purchases will take place two to three times a week, and the Fed may also buy other maturity Treasuries and Treasury Inflation-Protected Securities, according to a statement on the Federal Reserve Bank of New York’s Web site.

Thirty-year bond yields fell to a record low of 2.509 percent on Dec. 18, less than three weeks after Bernanke first mentioned the option of buying Treasuries. Yields had climbed to as high as 3.84 percent today.

Strategists at primary dealers UBS AG, Bank of America Corp., Morgan Stanley and Goldman Sachs Group Inc. had forecasted that central bank policy makers wouldn’t provide plans to purchase U.S. debt.

‘Powerful Bullet’

“We thought it was a lower-probability event, but we always knew that if the Fed did use this clearly powerful bullet, it would cause a huge drop in yields,” said Suvrat Prakash, an interest-rate strategist in New York at BNP Paribas Securities Corp., another primary dealer.

Yields on 10-year Treasury notes rose 33 basis points in the two days after the last policy meeting Jan. 28, when the Federal Open Market Committee said the central bank might buy longer-term Treasuries to revive lending but gave no further details.

During World War II, the central bank agreed to purchase unlimited amounts of government obligations from banks to keep interest rates low to finance the war, according to the Federal Reserve Bank of Atlanta.

Prior to cutting interest rates near zero, the New York Federal Reserve Bank bought and sold Treasuries almost daily to manage money supply and keep the Fed’s rate for overnight loans between banks near its target. The Fed held $474.6 billion of Treasuries on its balance sheet on March 11, $234.5 billion less than the year-ago period.

Global Central Banks

Expectations for U.S. purchases of Treasuries increased when the Bank of England said March 5 it would buy gilts. Yields on 10-year U.K. government bonds fell to a more than 20-year low of 2.93 percent March 13, from 3.64 percent before the policy was announced.

The Bank of Japan’s decision today to raise monthly purchases of government bonds to 1.8 trillion yen ($18.3 billion) added to the speculation.

“It’s wonderful for Treasuries,” said David Coard, head of fixed-income trading in New York at Williams Capital Group, a brokerage for institutional investors.

Buying Treasuries may help support President Barack Obama’s pledge on March 14 that investors can have “absolute confidence” in Treasuries. Chinese Premier Wen Jiabao said the day before he was “worried” about holdings of Treasuries and wanted assurances that the investment is safe.

China, the biggest foreign holder of U.S. debt, increased Treasury holdings by 46 percent in 2008and now hold about $740 billion, according to Treasury Department data.

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net; Dakin Campbell in New York at dcampbell27@bloomberg.net

Last Updated: March 18, 2009 18:31 EDT