More records were set as the week commenced along lower coupon MBS and 10-year Treasury note yields as a result of global growth and eurozone worries.

By midweek, however, the risk-on trade was finally seeing a return after encouraging remarks from the European Central Bank President Mario Draghi and some better-than-expected domestic economic reports, particularly on GDP, which saw the advance second quarter read slightly better than expectations at +1.5% while first quarter results were revised to +2.0% from +1.9%. At midday on Friday, prices on 30-year FNMA 3.0% through 4.0% coupons were down nearly 3/4 to 1/4 point from their highs.

This led to flows turning more two-way in production coupons from money managers and hedge funds following several weeks of a more decidedly one-way bent of buying. In addition, the modest backup led to a pickup in mortgage banker supply and some temporary supply/demand imbalances. Overall, however, originator selling on average clocked in at a minimal $1.8 billion per day, representing Friday through Thursday. This is especially true versus the Federal Reserve's daily average appetite of $1.3 billion.

Another factor possibly limiting appetite in lower coupons was the significant quantitative easing probability that was priced in. In research from Credit Suisse released Thursday, analysts said the QE3 probability was roughly around 80%, up from the mid-70% area in the prior week and mid-60%s in the week before that. The so-so performance in lower coupons "suggests that the market is unwilling to aggressively bake-in an increase in QE3 probability" beyond its current level, they added.

The better-than-expected GDP news seems unlikely though to have knocked QE probability very much off from its high perch partly as second quarter growth slowed from 1Q12, while many Wall Street economists noted that the recovery remained weak and at risk in the second half. The report, however, provides support for Federal Open Market Committee (FOMC) members to take no actions yet, or if anything, extend the "exceptionally low levels for the federal funds rate" to late 2015 from late 2014. More significant actions such as QE3 have been anticipated to occur at the September meeting.

Into the FOMC meeting and payrolls, BNP Paribas' MBS analysts were holding with a "modestly positive outlook on MBS" noting that an extension of low rate guidance would be supportive for down in coupon. As such, yield buyers and other investors are likely to take advantage of the late week price and supply-induced cheapening once the markets settled down and there was evidence of this already taking place late Friday morning as spreads on lower coupons were well off earlier weakness.

Also likely to keep interest in production coupons are traditional supportive monthly events that are looming over the next two weeks that include month-end index buying, lower volatility following release of the payrolls news, reinvestment of paydowns, and Class A pool allocations (Aug. 9). In regards to the first, Barclays MBS Index is projected to extend 0.10-years in July which is similar to its June average of 0.11-year and 12-month average also of 0.11-year. As far as paydowns, IFR Markets' estimated $134 billion will be available for reinvestment from $119 billion in June.

The back-up along with flows turning two-way contributed to a pickup in volume to a 103% average for the week through Thursday, based on Tradeweb's experience, up from 84% last week. It also led to buying up in coupon which was further supported by expectations that refinancings under the Home Affordable Refinance Program (HARP 2.O) were near peak levels.

For example, HARP-eligible 5.5s through 6.5s are seen increasing a modest 1%-2% in July, by 5% in August and slowing by 10% in September (day count is a significant influence in August and September). Fuller coupon performance was also aided by a steeper yield curve as a result of the sell-off.

Specified trading remained very active with payups strengthening further on strong demand from REITs, CMO desks, banks and money managers seeking call-protected paper. Refinancing risk looks to remain elevated as 30-year fixed mortgage rates set a new low this week of 3.49%, according to Freddie Mac.

Meanwhile, the Mortgage Bankers Association reported the Refinance Index increased another 2% to roughly 5421 in the week ending July 20, its highest level since April 2009.

GNMA/FNMA swaps were lower over the week with the exception of 3.5s as overseas investors were not enamored with price levels on GNMAs. Meanwhile, 15s were mixed versus 30s with the 3/3.5 and 3.5/4 swaps higher, while higher coupons were lower.

Over Monday through Thursday, Barclays' MBS Index lagged Treasurys by three basis points with month to date performance at +16. The 30-year Current Coupon yield declined to 2.36% from 2.43% with the spread to 10-year notes tightening two basis points to +95.

Despite the improved appetite for risk this week on better economic news and proclamations from Europe's crisis leaders to do "whatever it takes" and "to do everything to protect the eurozone", it is reasonable to expect that risk-off will be back and more records are on the foreseeable horizon.

Indeed, Fed Chairman Ben Bernanke noted in his recent Monetary Policy Report to the Congress that economic activity appeared to have decelerated somewhat in the first half of this year, the average increase in payrolls employment has dropped to 75,000 per month in the second quarter from nearly 200,000 per month during the fourth quarter of 2011 and first quarter of 2012, and that recovery is threatened by the financial strains associated with the euro zone crisis and the fiscal cliff. Some economists, in fact, are predicting the 10-year note yield to decline toward 1.25% by the fall in response to the global risks and central bank actions.

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