Many investors have expressed concerns about the changing supply/demand dynamics in the MBS market, in light of expected heavy refinancing activity. We will analyze the changing dynamics in some detail, arguing that MBS demand should rise more rapidly than net supply.

A steep curve and a recessionary environment tend to boost bank/thrift MBS demand while also leading to lower net fixed-rate production. This is clearly a positive dynamic for mortgages. Though heavy originations may lead to intra-day volatility in current coupon spreads, we expect that the trend should be for tightening mortgage spreads versus both Treasuries and swaps.

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