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Buzz and Banter

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Brian is in New York and stopped by the desk for a quick visit. As we were watching the market open this morning, we got to talking about two of our favorites, Fannie Mae(FNM:NYSE) and Freddie Mac(FRE:NYSE). FNM announced this morning that their duration risk had widened from minus one month to plus six months.

This in itself does not tell us much. We can view the gap as the "delta" or current exposure, but it tells us nothing of the "cost", as dictated by the volatility of the bond market, of getting this risk down. It also does not tell us what their "gamma" or future risk is to further moves in the bond market. What it does tell us is that they are working hard to keep the current level of their duration risk from growing. This is not necessarily a good thing. Because the "cost" or volatility of the bond market is higher, it is costing these companies more to manage their duration risk. That in turn is causing other market participants to do the same, feeding the growing volatility of the bonds even more.

FNM and FRE issued callable debt last spring, in lieu of cheaper non-callable debt, in order to try to mitigate some of this cost (it is closer in nature to their assets). This debt has significantly fallen in value as the market has realized the nature of the problem: most of the loss has been due to a rise in rates, but on the margin, callable debt is hurt more than non-callable by an increase in the volatility of bonds.

All this is also having the effect of pushing swap spreads out: agency spreads went from 8 basis points tighter on the day when Brian walked in to 3 basis points wider while we were having coffee. This is an enormous move in such a short time; FNM stock price went from up .40 on the day to -1.35 currently. We continue to expect higher volatility than normal in these stocks.

Positions in FNM and FRE

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