GSE Debt Trading Well

The yield spread between debt securities issued by Fannie Mae and Freddie Mac and U.S. Treasury securities has narrowed sharply today following a month of sharp widening. The narrowing probably reflects a sense that yields on agency securities have moved too far from Treasuries given the U.S. government's seizure of Fannie and Freddie in September.

The widening gained steam when the U.S. said it would back, through the FDIC, some new bank debt (newly issued senior unsecured debt). The widening occurred despite the fact that the market for new bank debt will probably be far smaller than the market for agency securities, which tallies around $1.7 trillion, and the fact that yields on any new bank debt would probably be a great deal lower than on bank debt with no government backing.

Last week, the yield spread between Fannie's 10-year and 10-year Treasuries increased to as high as 110.8 basis points from 90.4 basis points the Friday before.

Today, the spread is down 15.3 basis points to 94.8 basis points. The current level remains lofty compared to 2008's average of 67.7 basis points and last year's average of 45 basis points.

Agency securities and agency mortgage-backed securities need to trade well if the government's plans to help to help the financial system and the economy is to work.

For example, if yields on agency securities and agency-backed mortgage-backed securities were to rise, it would not only be bad for the housing sector, it would signal that the appetite for risk remained suppressed in ways that will harm the economy. Investors that shun agency securities are probably, by definition, shunning lesser-quality securities, such as corporate securities, which is why agency securities provide such an important signal. A continued contraction in yield spreads between agencies and Treasuries would signal an increase in risk-taking, which has obviously been devoid of late.

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Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of the revised investment classic, The Money Market, first published in 1978 by Marcia Stigum, and The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.

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