Shift out of two-year agencies into longer-dated paper as GSE uncertainty looms, says Cantor strategist

By Kenneth Lim

Boston, Sept. 3 - Two-year agencies do not offer any value now, and investors should move further out on the yield curve, according to Cantor Fitzgerald & Co. chief fixed income rates strategist George Goncalves.

A major issue heading into the final quarter of the year and the beginning of 2010 is the fate of the housing government-sponsored enterprises Fannie Mae and Freddie Mac.

The government will most likely keep the two agencies as mortgage guarantors and could enhance that insurance policy, but investors should not expect GSE debt to go onto the books of the government because that would pressure the dollar, Goncalves wrote in a quarterly outlook note.

"A major risk is that the government redesigns the GSE business model sooner than the market is expecting (potentially moving to a good/bad bank model)," he wrote. "This would result in wider spread moves in the mortgage basis but should favor Fannie debt out the curve as the need to [issue] long-term debt would fade."

If the public/private relationship is maintained but Fannie Mae and Freddie Mac mortgage portfolios are wound down, agency spreads could continue to tighten, Goncalves wrote.

But with the two-year sector already extremely tight, investors should look further out on the yield curve for value, he wrote.

"In agencies move up the curve in callables (out of the two-year sector) into the three- and five-year sector," Goncalves wrote.

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