* Fed program for mortgages boosts long-dated bonds
* US data on economic contraction, housing supports gains
* Prices extend gains after five-year note auction
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By Chris Reese
NEW YORK, Nov 25 (Reuters) - Longer-dated U.S. Treasuries surged on Tuesday as investors bet that a Federal Reserve plan to buy mortgage securities would spur a sustained need for government bonds in investor portfolios.
Further evidence of a shrinking economy and a flagging housing market, along with a well-bid 5-year Treasury note auction, added to the bullish tone for bonds and helped push benchmark yields down to near five-decade lows.
But analysts agreed that the main factor propelling Treasuries higher -- with the benchmark 10-year note rising a full two points in price -- was the Fed's announcement that it would buy housing-related securities with a $600 billion program in an effort to free up mortgage lending.
When the Fed purchases mortgages, investors will buy longer-dated Treasuries to maintain stable returns, the analysts said.
"The Fed is buying mortgages on an outright basis. They are buying fixed income so it supports the bond markets generally, not just mortgages," said Carl Lantz, U.S. interest rate strategist with Credit Suisse in New York.
"They are going to be buying mortgages from dealers who would have been short a Treasury as a duration hedge. Then the dealer buys back the Treasury and so covers his hedge," said Lantz.
When market participants "short" an asset they bet that its price will decline, adding to selling pressure in that asset. When market short positions are reversed, that tends to buoy the price of those assets.
The 10-year Treasury note <US10YT=RR> traded 2 points higher in price for a yield of 3.10 percent from 3.33 percent late on Monday. The yield, which moves inversely to price, neared the 50-year low of 2.99 percent reached on Thursday.
Bond price gains were also propped up by data showing the U.S. economy contracted at its fastest pace in seven years in the third quarter, as consumer spending dropped to a 28-year low. For details see [ID:nN25396155]
Data also showed that prices of U.S. single-family homes plunged by a record 17.4 percent in September from a year earlier.
Bonds extended gains on Tuesday afternoon after solid demand in a record-large auction of $26 billion of 5-year notes. Traders had worried that buyers would shun the auction due to its size and on expectations of a slew of further debt supply.
Two-year Treasury notes <US2YT=RR> traded 5/32 higher in price for a yield of 1.18 percent from 1.21 percent late on Monday, while 30-year bonds <US30YT=RR> traded 3-2/32 higher for a yield of 3.62 percent from 3.78 percent. (Additional reporting by John Parry; editing by Leslie Adler)
