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Agency Mortgage-Bond Spreads Fall Most in Two Years on Fed Move

Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates tumbled the most in more than two years relative to Treasuries after the Federal Reserve said it will reinvest proceeds from past purchases of housing debt into the bonds.

Fannie Mae’s current-coupon 30-year fixed-rate mortgage securities fell about 0.16 percentage point to 1.06 percentage point more than 10-year U.S. government debt as of 4:15 p.m. in New York, the largest drop since March 2009, according to data compiled by Bloomberg. That narrowing had followed the Fed’s decision to increase its initial buying of agency mortgage securities to $1.25 trillion from as much as $500 billion.

The Fed is switching tactics after previously reinvesting into Treasuries the cash generated by its holdings of agency mortgage securities and debt, as it sought to return to its traditional assets.

The central bank, which bought more than $1.4 trillion of housing debt through March 2010 to support the economy, plans to apply principal payments toward new purchases of home-loan bonds “to help support conditions in mortgage markets,” the Federal Open Market Committee said today.

Fannie Mae and Freddie Mac mortgage bonds trading closest to face value were soon “gapping tighter on the surprise,” Walt Schmidt, a mortgage strategist in Chicago at FTN Financial, said in a note to clients.

Treasury Purchases

The Fed also said today that it will buy $400 billion of Treasuries with maturities of six to 30 years through June while selling an equal amount of debt maturing in three years or less.

Yields on agency mortgage bonds have been guiding rates on more than 90 percent of new U.S. home lending following the collapse of the non-agency market in 2007 and a retreat by banks. The $5.4 trillion market includes securities guaranteed by government-supported Fannie Mae and Freddie Mac and bonds of government-insured loans backed by federal agency Ginnie Mae.

The central bank has also absorbed debt from the more than $2 trillion market of corporate borrowing by Fannie Mae, Freddie Mac and the government-chartered Federal Home Loan Bank system. It owned $885 billion of the mortgage bonds and $110 billion of the agency debt as of Sept. 14, after buying $1.25 trillion and $172 billion, according to Fed data.

The Fed’s portfolio of mortgage securities shrunk by about $14.4 billion last month and is set to pay down by about $21 billion next month, according to BNP Paribas SA analyst estimates. About $25 billion of the agency debt holdings will mature over the next year, according to Nomura Securities International Inc. analysts.

‘Dramatically Changed’

Today’s decision by the Fed means the “supply-demand technicals have dramatically changed” for agency mortgage bonds, the Nomura analysts led by Ohmsatya Ravi in New York wrote in a note to clients.

Domestic money managers, including real estate investment trusts, were poised to absorb about $390 billion to $400 billion of the debt, assuming loan rates stay around 4 percent, they said. With the Fed’s decision, the amount shrinks to $65 billion to $70 billion, according to their estimates.

“Because the expectation had been that there would be a gradual running down of the Fed’s balance sheet, and that’s not in the cards, the mortgage market as you would expect is doing very, very well,” Tad Rivelle, who oversees about $65 billion as head of fixed-income investments at Los Angeles-based TCW Group Inc., said in a telephone interview.

The average interest rate on a typical 30-year fixed loan fell to an all-time low 4.09 percent last week, as Europe’s sovereign debt crisis and a slowing U.S. economy drove investors to benchmark Treasuries and government-backed debt, Freddie Mac data show. The cost reached this year’s high of 5.05 percent in February.

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