June 17 (Bloomberg) -- Yields on Fannie Mae and Freddie Mac mortgage securities rose for the first day in five, suggesting interest rates on new home loans will resume their climb.

Yields on Washington-based Fannie Mae’s current-coupon 30- year fixed-rate mortgage bonds climbed 0.08 percentage point to 4.66 percent as of 5 p.m. in New York, according to data compiled by Bloomberg. Yields are down from 5.07 percent on June 10, the highest level since the Federal Reserve announced plans to buy home-loan bonds in November.

Mortgage-bond yields declined earlier as benchmark Treasuries rallied following a government report that showed the cost of living rose less than forecast in May. After “heavy buying” by the Fed late yesterday also propelled the difference between yields on mortgage bonds and government notes tighter this morning, “light” purchases by the central bank and sales by other investors pushed spreads wider, said Art Frank, head of mortgage-bond research at Deutsche Bank AG in New York.

“At the tights of the early afternoon, you had banks and money managers selling,” Frank said in a telephone interview.

The difference between yields on the Fannie Mae bonds and 10-year Treasuries widened 0.04 percentage point to 0.96 percentage point, Bloomberg data show. The gap, which grew to as much as 2.38 percentage points last year, contracted to 0.7 percentage point on May 22, the lowest since 1992.

Treasury 10-year notes fell this afternoon, snapping a four-day rally, as investors turned their attention to next week’s three note auctions, part of the government’s record borrowing to stimulate the economy.

Mortgage Securities Jump

The mortgage securities have soared from 3.94 percent on May 20, helping drive the average rate on a typical 30-year loan to 5.59 percent in the week ended June 11, up from 4.82 percent for the week ended May 21 and a record low of 4.78 percent on April 30, according to McLean, Virginia-based Freddie Mac.

The loan rate fell to 5.53 percent as of early yesterday, from a six-month high of 5.74 percent on June 10, according to Bankrate.com. Yield spreads over 10-year government notes on the mortgage bonds have recently narrowed from 1.14 percentage point on June 8, the widest in two months.

“I do not think that a drop in the effective mortgage rate really matters until it drops back below 5 percent,” said Scott Buchta, a strategist at Guggenheim Capital Markets LLC in Chicago. Even then, new rules intended to increase refinancing of loans owned or guaranteed by Fannie Mae and Freddie Mac would have to be expanded, he said.

The companies would need to allow refinancings by borrowers who owe as much as 25 percent more than the value of their homes, he said. The limit, under the “Home Affordable” program created by President Barack Obama this year that he said may aid 4 to 5 million homeowners, is now 5 percent more than the value.

Supply, Demand

Hedging by mortgage-bondholders and services had driven some of the recent increases in Treasury yields and spreads on home-loan bonds, a dynamic that is now being reversed.

“A lot of the movements in Treasuries have come because of supply and demand from other markets, namely mortgages and swaps,” said Adam Brown, a managing director and Treasury trader at primary dealer Barclays Capital in New York. “The Treasury market has been the tail of the dog and not the dog itself.”

As rates increase, the expected average lives of mortgage bonds and loan-servicing contracts extend as potential refinancing drops, leaving holders with portfolios of longer- than-anticipated durations. Investors then may seek to pare durations by selling longer-dated Treasury securities, mortgage bonds and interest-rate swaps, sending yields even higher. The opposite happens when rates decline.

Change in Duration

The duration of the agency mortgage-bond market extended to the equivalent of about $1.9 trillion of 10-year Treasuries as of yesterday, almost double the year-end level of about $1 trillion, Chris Ahrens, Jeana Curro and Eric Liverance, UBS AG strategists in New York, wrote in a report today.

Duration is an estimate of how much the price of a bond will change when interest rates rise or fall. The duration of fixed-rate agency-mortgage bonds fell to 3.18 years as of yesterday, down from a seven-month high of 3.85 years on June 10, according to Barclays Capital index data.

“For those who believe rates will go down, hedge ratios will certainly shrink, which will result in an immediate contraction as borrowers refinance,” the UBS analysts wrote. “We do not expect to see 4.875 percent mortgage rates anytime soon and consequently anticipate the market will stay extended for some time.”

Yields on agency mortgage bonds are guiding rates on almost all new U.S. home lending following the collapse of the non- agency market in 2007 and a retreat by banks. The almost $5 trillion market includes securities guaranteed by government- controlled Fannie Mae and Freddie Mac and bonds of U.S.-insured, low-down-payment loans backed by federal agency Ginnie Mae.

The consumer price index increased 0.1 percent in May after no change a month earlier, capping the biggest 12-month decline since 1950, the Labor Department said today in Washington. Economists forecast consumer prices rose 0.3 percent, according to the median of 75 projections in a Bloomberg News survey.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

Last Updated: June 17, 2009 17:55 EDT