The Fed's surprise half-point cut last Wednesday caused a "buying frenzy" in the mortgage arena, but could reignite the refi wave, said industry sources.

"The tighter yield curve is a pretty big plus for MBS that resulted from the Fed's move," said Art Frank, head of MBS research at Nomura Securities.

The steep curve, which makes CMO arbitrage more attractive, is also a major plus for dealers who want to own 6.5s and 7s for potential CMO deals, said Frank.

According to Frank, last Wednesday's Fannie Mae current coupon was nine basis points tighter than where it was on Tuesday's close, down to 145 basis points over the 10-year Treasury from 156 basis points over the 10-year Treasury. Swaps and agencies also tightened about 5 basis points over the 10-year Treasury.

However, Frank said that the decline of 19 basis points in absolute level of current coupon yield on Wednesday may restart the refi wave.

Before the Fed cut, the MBA's Refi Index had been slowing and were it not for the Fed's rate cut, this week's Refi Index would likely have been under 2,000.

And on Monday and Tuesday last week, yields were at a point where people were finding value in spread product. Judging from these yields, pre-payment speeds would have slowed substantially by June. However, because of the Fed cut, "that's probably no longer in the cards," said Frank.

Last Wednesday's surprise cut will also have different results from the surprise cut that happened back in January.

"The big difference now vs. the Fed cut in January was mortgages were very wide then," said David Montano, a director of MBS research at Credit Suisse First Boston. Since mortgages are currently fairly tight, there's not as much upside.

And though the curve is in favor of mortgages, the market is also rallying: 6.5s are at par again, while mortgage rates are down to the 7% level. "That basically maintains us in a refi environment," Montano stated.

"We expect more demand from banks with the lower discount rates," Montano said. "So we believe the bank demand should help particularly the 15-year sector. We're very bullish on the 15 years."

Post Fed cut reaction

Players were proactive last Thursday, as they sold longer-dated securities and moved down the curve in anticipation of another 50-basis-point cut in mid-May, sources said. Worries that last Wednesday's rally resulted in some movement lower in mortgage rates - thus heightening concerns regarding prepayments - were laid to rest with the more-than-one-point drop in 10-year prices. The yield was backed up to 5.28% - three basis points higher than last Monday's close of 5.25%

For the near term, the prepayment picture appears improved, sources said. This, however, could change later this summer or early fall. At the moment, consensus is generally leaning towards a 50-basis-point rate cut in May, and then pausing. A few firms, however, believe the Fed will have to make additional rate cuts in the third quarter to stimulate the economy.

But still the interest rate environment remains volatile, investors cannot just sit back and relax.

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