June 10 (Bloomberg) -- Yields on Fannie Mae and Freddie Mac mortgage securities rose, setting a new high since the Federal Reserve announced plans to buy the bonds to drive down interest rates on new home loans and further thwarting the effort.

Yields on Washington-based Fannie Mae’s current-coupon 30- year fixed-rate mortgage bonds rose 0.09 percentage point to 5.06 percent as of 3 p.m. in New York, according to data compiled by Bloomberg. That’s the highest since Nov. 24, the day before the U.S. central bank announced its plans to buy home- loan bonds. The level is up from 3.94 percent on May 20.

Today, yields advanced largely in line with a climb in rates on benchmark 10-year Treasuries, as the government sold $19 billion of the securities and Russia said it may switch some of its reserves from U.S. debt. The “agency” mortgage-backed securities market has also been roiled by widening yield premiums relative to government notes.

“You know the Fed is going to be buying, so investors aren’t underweighting agency MBS per se, but they are taking off their overweights as spreads have tightened well beyond historical averages,” said Scott Buchta, a strategist at Guggenheim Capital Markets LLC in Chicago. “What you’re starting to see people look at is: What happens when the Fed stops buying?”

U.S. mortgage applications fell last week to the lowest level since February as a jump in borrowing costs discouraged refinancing and signaled that Fed Chairman Ben S. Bernanke’s bid to cap rates is stalling, according to Mortgage Bankers Association data released today.

The Fed’s Strategy

The Fed initially said on Nov. 25 that it would buy as much as $500 billion of mortgage securities, before announcing in March that it would expand the program to as much as $1.25 trillion, as well as buy $300 billion of Treasuries. The average rate on a typical 30-year mortgage rose to 5.56 percent as of early yesterday, from 4.85 percent on April 28, the lowest on record, according to Bankrate.com data.

“The homeowner can’t handle this,” said Scott Simon, the head of mortgage-bond investing at Pacific Investment Management Co., whose Newport Beach, California-based firm is the world’s largest fixed-income manager.

Higher rates are “really hurting the refi wave,” Buchta said in a telephone interview. “And rising rates are definitely going to hurt home prices. Consumers figure out the payment they can afford and from that figure out how much house they can buy.”

An increase of 0.5 percentage point in loan rates translates into about 5 percent “less buying power,” he said.

Fannie-Treasury Gap

The difference between yields on the Fannie Mae bonds and 10-year Treasuries rose 0.02 percentage point today to 1.13 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.

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 housing market faces challenges. Additional U.S. home foreclosures will probably total 6.4 million by mid-2011, about 2.5 million less than if mortgages weren’t being reworked to aid borrowers, according to JPMorgan Chase & Co. analysts.

The modification-adjusted number, from a starting point of March, will lessen home-price declines “only slightly,” the mortgage-bond analysts led by John Sim in New York wrote in a June 5 report. Instead of falling 41 percent from their peaks, U.S. prices will probably drop 39 percent on average, they said.

Completed foreclosures totaled 861,664 last year, up from 404,849 in 2007, according to RealtyTrac Inc., an Irvine, California-based seller of foreclosure data. In the first four months of this year, they totaled 276,526.

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

Last Updated: June 10, 2009 16:03 EDT