As expected, Fannie Mae continued to shrink its mortgage portfolio in May by a whopping $24 billion, and is expected to do so further in June. This is the seventh consecutive month of Fannie portfolio contraction, bringing it down to the smallest it has been since June 2003. The huge drop was from a roughly $17 billion runoff as well as $18 billion of net sales, partly offset by $11 billion of purchases.

The dip could adversely impact the MBS agency market, said analysts. "In all, the decline in the Fannie portfolio and the lack of growth in the agency side of the Freddie portfolio could continue to weigh somewhat on the agency market, particularly since there is some indication that banks have sold MBS as well," said a Merrill Lynch report, noting that although Freddie Mac's portfolio grew for the fourth consecutive month in May, all of the growth was in non-agencies. The drop's negative impact on MBS would be especially true if rates were to rally; but in a back up, analysts said mortgages should perform reasonably well.

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