Sectors mixed as government role mulled

NEW YORK (Reuters) - Yield spreads on Fannie Mae and Freddie Mac U.S. mortgage-backed securities tightened against Treasuries on Friday, while most "federal agency" debt ended wider as front-end supply weighed on the sector.

The Federal Reserve's regular buying has been the biggest positive for agency MBS and agency debt securities, but the purchase programs have inflated the prices of some securities to levels that some investors deem unappealing.

Agency MBS are almost guaranteed to cheapen when the Fed ends its program to buy the bonds in less than five months. Market participants are concerned that another deep-pocketed investor may not step up to fill its void in a marketplace where the central bank has been by far the largest buyer.

"There is a common fear that there are not any agency MBS buyers at these levels," said Vivek Sriram, strategist for MBS and derivatives at RBC Capital Markets in New York.

"Even though the Fed has slowed down its weekly purchases, the market is still tight," he said.

But buyers should emerge at cheaper levels, which should limit any widening, he said.

Sriram said on an option-adjusted basis, mortgage bonds could widen by 25 to 35 basis points after the Fed exits the market.

There is still tremendous positive carry in owning agency MBS, but up-in-coupon trades, which entails selling lower yielding coupons in exchange for higher yielding issues, is a better bet than down-in-coupon trades, he said.

"We believe it is prudent to stay neutral on the mortgage basis," he said.

The yield spread on the 30-year Fannie Mae 4.50 percent current coupon was 128 basis points over the 5- and 10-year Treasury blend on Friday, about 6 basis points tighter than Thursday's close, according to Arthur Frank, director and head of MBS research at Deutsche Bank Securities in New York.

"Buying from money managers was strong today," he said.

The securities have richened so far in November after ending October at 144 basis points.

Mortgage bonds have also fared well this year.

The yield spread ended 2008 at about 201 basis points and is significantly below the widest level on record set on March 6, 2008, at 293 basis points, he said.

The Fed's purchases of agency MBS and agency debt so far in 2009 total roughly $1.007 trillion and $152 billion, respectively. Meanwhile, its $300 billion of Treasuries purchases has concluded. The purchases are part of the Fed's effort to lower borrowing costs.

The Fed is committed to buying the entire $1.25 trillion allotted for its agency MBS program by the end of the first quarter of 2010. The Fed recently revised the target size of its agency debt purchase program to about $175 billion from up

to $200 billion and should also be completed by this time.

Active 15- and 30-year mortgage securities were 3/32 to 8/32 higher. Prices on 30-year 4.50 percent coupons were 8/32 higher. Bond equivalent yields on 30-year 4.50 percent coupon MBS ranged from 3.967 percent to 4.101 percent.

Prices on 30-year 5.00 percent coupons were 3/32 higher. Bond equivalent yields on 30-year 5.00 percent coupon MBS ranged from 3.424 percent to 3.629 percent.

Yield spreads on agency debt securities ended 0.5 to 2 basis points wider amid the latest round of supply.

The Federal Home Loan Bank System priced $3 billion of two-year global bonds.

U.S. 10-year Treasury notes were 4/32 higher at 99-16/32 with a yield of 3.433 percent. Yields, which move inversely to price, were down from Thursday's 3.45 percent.

(Additional Reporting by Caryn Trokie; Editing by Kenneth Barry)