Treasurys retreat after rally

Prices for U.S. government bonds ease after surging in the previous session on the Fed's decision to buy debt.

NEW YORK (CNNMoney.com) -- Treasury prices eased Thursday as investors responded to the Federal Reserve's plan to buy $300 billion in long-term government debt and braced for next week's auctions.

In a policy statement Wednesday, the Fed said it would buy a total of $1.2 trillion in assets to help increase activity in the credit markets.

By purchasing Treasurys, which the Fed will do over the next six months, the central bank hopes to drive down interest rates on several types of loans. In addition to the $300 billion in Treasurys, the Fed also announced plans to buy $750 billion in mortgage-backed securities.

Treasurys prices soared Wednesday after the announcement. The yield on the 10-year note marked its largest single-day drop in over three decades. Bond prices and yields move in opposite directions.

But prices churned Thursday as investors awaited more details on the plan, including which maturities the Fed will focus its purchasing operations on.

While the Fed's policy statement indicated it would buy longer-term bonds, the Federal Reserve Bank of New York said Wednesday that the purchases - to be made across the yield curve - would focus on notes in the range of 2 to 5 years in duration.

"The market is continuing to adjust to the belief that the Fed will focus its buying on the middle of the yield curve," said Steve Van Order, chief fixed-income analyst at Calvert Funds. "Anytime there's a surprise announcement of this magnitude you always get this kind of volatility."

The Fed said it would provide further details early next week. It plans to begin buying Treasurys late next week, and will hold purchase operations an average of 2 to 3 times a week going forward.

Supply: The Treasury Department said it will offer a total of $98 billion in government debt next week after auctioning $63 billion last week.

The Treasury will auction $40 billion in 2-year notes on Tuesday; $34 billion in 5-year notes on Wednesday and $24 billion in 7-year notes on Thursday.

The auctions come as the government is set to pay for $787 billion in economic stimulus and $700 billion to stabilize the financial system.

"Treasurys will be coming out of our ears - they already are," said Kim Rupert, fixed income analyst at Action Economics. With so much supply coming to the market, the Fed may have to increase its purchases of Treasurys, she added.

"I think $300 million is just a drop in the bucket," Rupert said. "The Fed might have to up the ante if they want to keep yields low."

Inflation: The Fed's aggressive new spending campaign, which will effectively increase the money supply, raised some concerns about inflation in the future.

While most economists say the threat of inflation remains distant, bondholders are concerned that it could become a problem once the economy recovers.

Rising prices severely erode the value of fixed income assets such as Treasury bonds.

"The bond market is going to be concerned about inflation," Van Order said. "Right now it's hard to imagine, but the Fed's program could have big inflation implications."

Treasury prices: The benchmark 10-year note was down 17/32 to 101 10/32 and its yield rose to 2.6% from 2.53% late Wednesday.

The 30-year bond was down 1 24/32 to 97 23/32 with a yield of 3.63%.

The 2-year note slipped 3/32 to 100 1/32 and yielded 0.87%.

Lending rates: The 3-month Libor rate fell to 1.23% from 1.29% Wednesday, according to data on Bloomberg.com. The overnight Libor rate eased to 0.3% from 0.31%.

Libor, the London Interbank Offered Rate, is a daily average of rates that 16 different banks charge each other to lend money in London.

Two credit market gauges reflected increased liquidity. The "TED" spread shrank to 1.04 percentage points from 1.08 percentage points. The narrower the TED spread, the more willing investors are to take risks.

The Libor-OIS spread narrowed to 1 percentage point from 1.07 percentage points. A narrower spread indicates that more cash is available for lending.