Sectors mixed as government role mulled

By Julie Haviv

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.