Mortgage spreads were hit as buying slowed down following the weak employment report. The 10-year yield rallied 18 basis points on Jan. 9 to close at 4.08%. Last week, the market stayed firm and finally closed below 4% on Wednesday. Originator selling also picked up and averaged about $1.5 billion per day. Since the start of the year, originators have brought over $11 billion, mostly in 5s and 5.5s. Over the week before press time on Thursday, spreads on 30-year Fannie Mae's were six basis points wider in 5s and 5.5s, and three basis points weaker for 6s and 6.5s. Dwarfs are plus eight to 10 basis points in 4.5s through 6s. Somewhat surprising has been the limited convexity buying in Treasurys so far. It is expected to pick up, however, if the 10-year yield falls much further from Wednesday's close.

The impact of lower rates was initially wider spreads, but investor interest started to return in Thursday's trading session on the recent cheapening and a light supply day. At mid-day, spreads were slightly tighter. In comments last week, suggested that mortgage spreads are likely to widen if the market rallies or rates hold at current levels. An increase in supply initially will not be met by banks or the GSEs until some widening occurs - UBS suggests five to seven basis points cheapening for banks, and around 10 basis points for the GSEs. At the same time, mortgage spreads are expected to widen in a sell-off as a result of supply; however, after that is absorbed, JPMorgan Securities says mortgages should outperform as investors appear to be short.

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