Total agency MBS issuance for 1H09 totaled $916 billion with net issuance at $286 billion.

Contributing to the strong issuance has been the increasing prepayment volume as well as the securitization of Fannie Mae's portfolio.

Gross issuance in the second half of the year, however, is not expected to keep pace with the first half as volume projections are for under $750 billion, while net issuance looks to be in line with the first half of the year.

Supply outlooks have been lowered because of the higher mortgage rates and limited response to the government's Home Affordable Refinance Program (HARP).

In its July outlook, the Mortgage Bankers Association projected the 30-year fixed mortgage rate to average 5.4% and 5.5%, respectively, in 3Q09 and 4Q09, up from a 5.0% average in 2Q09 and versus a previous projected average rate of 5.3% for both 3Q09 and 4Q09.

On the demand side, as of July 23, the Federal Reserve had $568 billion left to go in their program to buy $1.25 trillion in agency MBS this year. The Fed's weekly buying has been in the $20 billion area in July, down modestly from previous months. However, with the Fed yet unclear on various issues regarding their various purchase programs, JPMorgan Securities analysts believe the Fed will continue at its current pace for now.

Meanwhile, Treasury purchases have declined fairly steadily since the Fed began its MBS buy program in January. Late last year and into January, the Treasury bought over $20 billion per month, but in June it was down to just over $5 billion.

Is the program winding down? That is unclear, analysts said, but even so, it is not necessarily worrisome, especially as demand from bank sources look to take up some of the Treasury's slack.

"Historical relationships among agency MBS holdings, deposits and total securities portfolios show that there should be more room for MBS growth, perhaps by as much as $100 billion over the next year," JPMorgan analysts stated.

The factors supporting this growth are declines in loan growth as consumers and businesses cut back on borrowing because of the recession, job worries and tight credit standards, as well as the favorable spread between MBS yields and deposit rates.

Based on the decline in supply and steady support from the Fed, "the supply/demand landscape is a positive for the sector," Barclays Capital analysts said.

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