Last week's hearings on a bill to toughen oversight of Fannie Mae and Freddie Mac reassured the market for the two government-sponsored enterprises' debt.
Fannie and Freddie officials were stubborn in testifying against the bill before a House Banking subcommittee last Tuesday, which seemed to confirm predictions that the legislation would go nowhere this year. Accordingly, investors bid up the price of agency debt securities, pushing yields lower.
Friday morning, 10-year agency bonds were trading at yields 15 basis points lower than the 10-year swap rate. A week before, they had been trading only 11 basis points lower.
In March, before Treasury undersecretary Gary Gensler's congressional testimony shook investors' confidence in Fannie and Freddie debt, 10-year agency bonds yielded 20 basis points less than the swap rate.
"The market believes the Gensler genie is halfway back in the bottle," said Arthur Q. Frank, director of fixed-income research at Nomura Securities International Inc.
The swap rate is increasingly being used instead of Treasury bonds as the benchmark for the credit markets. It represents the cost to a high-rated financial institution of entering into an interest rate swap agreement.
In his March testimony, Mr. Gensler backed some provisions of the oversight bill, which was introduced by Rep. Richard H. Baker, R.-La., in February. Specifically, Mr. Gensler said the Treasury would support a repeal of a conditional line of credit that Fannie and Freddie have with the Treasury. The credit line is the basis for investors' assumption that if Fannie or Freddie were to get into trouble, the government will bail them out.
That implied guarantee from the government has enabled Fannie and Freddie to borrow at lower rates than most financial institutions. But Mr. Gensler's testimony, in which he repeated several times that the GSEs' securities are not government-guaranteed, scared some investors into selling off agency bonds. That pushed up yields and, with them, Fannie and Freddie's borrowing costs.
Last week's market activity indicated that fears that the GSEs' implied guarantee is in jeopardy have been largely assuaged.
"Most participants will have concluded, as Mr. Baker himself said in a press conference following Tuesday's testimony, that his bill has no hope of enactment" this year, said Michael D. Youngblood, a managing director at Banc of America Securities LLC in Charlotte, N.C.
But observers such as Medley Global Advisors in New York said that although the Baker bill may not pass this year, it should not be presumed dead. It "has gained far more political momentum than you would imagine from reading the press or investment house research," a Medley research note to clients said.
Market sources said the Medley report, which was distributed to hedge fund clients Thursday morning, sparked short-lived selling of agency securities that day.