Bonds up as mortgage rates fall
Investors hedge against falling yields for mortgage-backed securities.
NEW YORK (CNNMoney.com) -- U.S. treasurys rose on Monday after a government bailout of mortgage giants Fannie Mae and Freddie Mac drove down mortgage rates.
The benchmark 10-year note rose 9/32 to 102 22/32, while its yield fell to 3.67% from 3.7% on Friday. Prices and yields move in opposite directions.
The price of the 30-year long bond rose 24/32 to 103 30/32, with its yield falling to 4.26% from 4.3%.
The short-term 2-year note rose 1/32 to 100 4/32, and its yield fell to 2.31% from 2.32%.
Mortgage rate hedging: Investors purchased government debt as a hedge against prices of mortgage-backed securities (investment bundles of mortgage debt), which rallied due to falling mortgage rates, according to Steve Van Order, chief fixed income strategist at Calvert Funds in Bethesda, Md.
As mortgage rates fall, it increases the likelyhood that homeowners will refinance and pay off their mortgages sooner (pre-pay). This drives up the price of mortgage-backed securities.
Higher prices lead to lower yields, since the difference between the price investors pay for debt versus the amount that is expected to be returned when that debt is paid in full shrinks.
"[Mortgage-backed securities] rallied so strongly that people were concerned about pre-payment risk on a lot of these things," said Van Order.
Mortgage rates fell about 0.5% on Monday - a pretty significant percentage, according to bankrate.com analyst Greg McBride.
"The question [that] remains is how much of that sticks," said McBride.
Mortgage bailout: Bonds initially fell following the government's announced takeover of mortgage finance companies Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) over the weekend.
Treasury Secretary Henry Paulson and Federal Housing Finance Agency director James Lockhart announced the bailout Sunday, sparking stock rallies worldwide, and pulling investor money out of the less lucrative bond market.
Bonds sold off at the start of trading Monday amid fears that the government would need to issue new debt to pay for the takeover, according to Andrew Brenner, senior vice president of MF Global in New York.
Loans and loan guarantees held by Fannie Mae and Freddie Mac are worth more than $5 trillion. As of this past weekend, all of those obligations are now being supported by the Federal government.
Under the takeover plan, the two companies will continue to operate as separate entities under Federal management, reducing the chance the government would flood the market with new debt in the near term.
"Absolutely (new debt) is a concern," said Brenner, "but not today."
Reaction to stocks: Also on Monday, the stock rally in the U.S. faltered in mid-day, but picked back up again as trading drew to a close in New York.
The mid-day dip brought bond prices out of negative territory as the initial euphoria of the Treasury Department's actions wore off.
Stocks and bonds often move in opposite directions as investors purchase one type of investment in reaction to weakness or strength in the other. But as stocks began to climb again on Monday, the hedging in the mortgage-backed securities market took over, and drove up bonds as well.