Big bond investors say Fed plan works -- for now

NEW YORK (Reuters) - The Federal Reserve's move to unfreeze panicky U.S. credit markets failed to assuage bond investors, with some of the biggest fixed-income investors braced for further credit deterioration in the market.

On Tuesday, the Fed said it will lend up to $200 billion of Treasury securities to banks for 28-day periods in return for debt including a range of mortgage-backed securities -- the root of the current credit crisis -- as collateral.

That news did send the yield premium on Fannie Mae MBS down 15 basis points to 2.151 percentage points over comparable Treasuries, but not before it hit its widest level in more than 20 years on Thursday, at 2.37 percentage points.

Mounting foreclosures and defaults along with further rating downgrades remain the clear and present danger.

"The negative fundamentals are very much intact for delinquencies and foreclosures, and the selling pressure from leveraged investors still looms large over the market," said Jeffrey Gundlach, chief investment officer of TCW Group in Los Angeles, which invests $160 billion.

To the shock of many investors, and evidently Fed policy makers, mortgage-backed securities, known as some of the least volatile and safest securities, had been under severe selling pressure until Tuesday.

Over the last week alone, banks and hedge funds stripped of access to credit have had to sell these mortgage securities to raise cash for margin calls, which have consequently created somewhat of a "systemic" liquidity squeeze.

But the Fed action on Tuesday may mark a short-term bottom after some six straight weeks of "outright brutality," said Gundlach, who is also one of the biggest MBS investors.

"This was very important news for the dealers who have seen their capital constrained," said Dan Fuss, vice chairman of investment company Loomis Sayles, which oversees over $100 billion in fixed-income securities. "At least they have a warehouse for their mortgages and they have a little more capital to use elsewhere."

The road to a lasting recovery remains long and difficult.

Already, Fannie Mae and Freddie Mac, the mortgage-finance giants, have faced large losses in the last quarter, and rising default rates on U.S. home mortgages have spawned questions over the quality of debt and MBS issued by the two companies.

Investor confidence in the mortgage-backed securities market has become more important since 2006, with lenders now calling government-sponsored enterprises Fannie and Freddie "the only game in town" for housing funds.

So it shouldn't be too much of a coincidence that the central bank injected liquidity in the way that they did, said Bryan Whalen, portfolio manager at Metropolitan West Asset Management in Los Angeles and another big MBS investor.

"It was a move in improving investor psychology," Whalen said.

Added Whalen: "If there was news about another REIT or another hedge fund having their lines pulled, I think you will probably unwind everything and all the positive sentiment immediately."

(Additional reporting by Al Yoon and Julie Haviv; Editing by Leslie Adler)