Bond futures tumble after takeover of GSEs

By Richard Leong

NEW YORK (Reuters) - U.S. Treasury bond futures fell sharply late Sunday, kicking off the week's trading after the government took over struggling mortgage finance giants Fannie Mae (FNM.N) and Freddie Mac (FRE.N) in what could be the biggest U.S. bailout ever.

The move, announced on Sunday, triggered a massive rally in stock index futures, curbing safe-haven bids for bonds.

Moreover, the takeover is seen likely to mean more government borrowing and federal exposure to risky mortgage assets which have been battered by the housing slump.

The U.S. Treasury said it will immediately take $1 billion equity stakes in each of the two government-sponsored but shareholder-owned enterprises.

The government's ownership could grow as much as $100 billion each and would be senior to both existing preferred and common shares.

"You are using the Treasury balance-sheet to help the stock and mortgage markets," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "This is not good for Treasuries."

"But this is what the Treasury has to do," Ablin said of the federal takeover of the two companies, whose financial health is considered critical for the battered U.S. housing market and global financial system.

The futures sell-off wiped out much of last week's gains tied to anxiety about a weakening economy and data suggesting inflationary pressure, especially from oil, is waning.

CBOT Dec 10-year T-note futures were down 1-24/32 from Friday's close at 114-28/32, their lowest in two weeks, while the Dec T-bond contract were down 1-21/32 at 117-13/32, its lowest in five sessions.

Short-term interest rate contracts also fell hard, especially those for delivery after 2009. June 2009 Eurodollar futures were down 22 ticks at 96.815, while other deferred contracts were off as much as 32 ticks.

The drop in rate futures implies that traders are betting the Federal Reserve may begin raising benchmark interest rates by the end of the first quarter of 2009.

On Friday, many Wall Street firms said they see the Fed keeping the overnight federal funds rate target at 2.00 percent into mid-2009, according to a poll conducted by Reuters. (Editing by James Dalgleish)