Selling in discount mortgages by hedge funds and money managers by the end of last week picked up, as investors took advantage of the recent richening in the sector. However, prepayment fears and the apparent onset of a refinance boom sent ripples of fear into the mortgage market amid a week of down-in-coupon trading.

There was some nibbling in higher coupons as cheapening on prepayment fears has been overdone, though the prepayment risk deterred others into agencies, sources said. Near close last Thursday night, mortgage performance was mixed partially due to the flattening in the yield curve. Thirties underperformed by two ticks. Discounts, especially 7s, were the worst performing coupons last week, trailing premiums by one to three ticks. Fifteens were flat to slightly lower.

On the selling in discounts and moves up-in-coupon late last week, discounts were one to two basis points wider while premiums were unchanged to one basis point tighter. The exception was 7.5s, which were one to two basis points weaker on fears that this latest rally has brought this coupon fully into-the-money. Bear Stearns warned that 2030 WAM conventional 7.5s were particularly vulnerable to big increases in prepayments. Mortgages again lagged swaps and agencies last week.

"There is a lot of down-in-coupon buying, but it is a very, very rich market in mortgages," said an MBS analyst. "There is the suggestion that mortgages will see some decent selling, and agencies tighted by two basis points. Everybody is scrambling to buy discount paper."

Last Thursday, one account reportedly sold up to $2 billion in mortgages in order to buy five and 10-year agencies, a way to take out prepayment risk. Sources indicated that this points to the fact that the fear factor is quite high right now, and might be a knee-jerk reaction to the possible Refi wave that is set to approach next year.

"There will be a lot of volume pick-up in prepayments going forward into next year," said an MBS trader. "This should stimulate some purchase activity too. January is a good bet for when we'll see some of this prepayment data, especially in Fannie numbers."

In the Markets

Also last week, interviews began for the leadership position of the House Banking Committee. Interviewees include Rep. Marge Roukema, who is considered the front-runner, based on longevity and gender.

Competing for the position is Rep. Richard Baker, head of the capital markets subcommittee and the official who spearheaded GSE reform. There is a dark horse contender, Rep. Michael G. Oxley of Ohio, who is interviewing for head of the House Commerce Committee. If he doesn't get that position, GOP leaders supposedly are considering transferring the jurisdiction of the Commerce's finance subcommittee to Housing Banking and giving him the Chairmanship there.

In commercial MBS last week, Lehman Brothers hired John Beaman from Credit Suisse First Boston to trade CMBS. Beaman, a vice president, is an ex-DLJ employee who moved to CSFB when it recently completed its $13.4 billion purchase of the DLJ. At Lehman, Beaman will report to Ken Cohen, who heads Lehman's CMBS trading effort .

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