Bonds Prices Fall on Fannie, Freddie Worries

Treasury debt prices fell Friday on fears of increased government debt issuance after a report that the U.S. government may be considering a takeover of the country's two biggest mortgage finance companies.

That report also sparked a rally in agency debt, which drew flows away from Treasuries.

Bond losses were somewhat tempered however after U.S. Treasury Secretary Henry Paulson said the Treasury Department's chief aim was to back Fannie Mae and Freddie Mac in their "current form," and offered no hints on a possible rescue plan.

The New York Times reported Friday the U.S. government was considering taking over one or both of the companies if their funding problems worsen. The report sparked a plunge in their shares, while their debt rallied.

"The traders are operating on the assumption the government will back the (government-sponsored agencies') debt,'' said Lou Brien, market strategist at DRW Trading in Chicago, adding ''this is a spread trade—shorting Treasuries and longing agencies.''

"The trade today is the move out of Treasuries and into agency debt,'' said Jim DeMasi, chief fixed income strategist at Stifel Nicolaus & Co in Baltimore. "There's a closer linkage today with Fannie, Freddie and the U.S. government than ever before,'' he said.

"The recent remarks from government officials reinforce the expectations of an eventual takeover of the GSEs by the government. That's positive for agency bondholders. It's a credit quality upgrade,'' DeMasi said.

Bonds also found a negative tone Friday from data showing slightly higher-than-expected U.S. consumer confidence. The Reuters/University of Michigan Surveys of Consumers said the preliminary July reading for its index of consumer sentiment edged up to 56.6 from June's final result of 56.4. Wall Street had expected a July reading of 55.5.

Further complicating the picture was a drop in U.S. stocks on worries Fannie Mae and Freddie Mac might run short of capital, and a surge in U.S. crude oil to records above $147 per barrel. Normally such a drop in stock prices would lend Treasuries a near-term flight-to-safety bid.

"Whenever you get markets like this, you get a flight to quality and that goes to either Treasuries or cash. The credit problems in these markets are affecting everything,'' said Joe Keetle, senior wealth manager at Dawson Wealth Management in Cleveland, Ohio.