Dealers and MBS traders noted a "delayed reaction" to the 50-basis-point Fed rate cut last Wednesday, as the FOMC move was, for the most part, already priced into the market.

"Overall, mortgages have done well, especially the 15-year sector," said David Montano, director of mortgage-backed research at Credit Suisse First Boston. "The overall market gradually rallied this time around, and 6.5% coupons were trading above parity."

There was increased buying in 15-year coupons and 30-year discounts, which one analyst described as a knee-jerk reaction to negative convexity and prepayment issues.

One pass-through trader noted only a moderate flow into 15-year paper, however, and said that many accounts were willing to extend out for five years and buy 20-year paper in order to pick up more yield. "There is no shortgage of guys coming in doing 20-year 7s," the trader said. "Liquidity is fine right now."

Additionally, a steeper yield curve signalled a steepening arbitrage potential for CMO deals. As a consequence of this, several traders mentioned a shortage of jumbo 6.5 coupons last week.

"I couldn't find these bonds on the Street," said one trader. "I think maybe two people had them. They're all going into CMO deals."

Additionally, small coupon cohorts, especially ones with fast prepayments, are very prone to shortages as well, sources said. For instance, conventional 8% production over the past year has been more than four times as large as that of 8.5s, and 8.5s account for less than 6% of the total.

"At this point, investors that own 8.5%s should probably hang onto them," said an MBS report from Countrywide Capital Markets. "Accounts looking at premium coupons, however, should avoid the situation entirely and buy Fannie 8%s. It is a much larger and more liquid cohort, and investors can pick up 8 basis points in LOAS versus an average give-up (compared to 8.5s) of more than 10 basis points."

Prepayment fears return

Street expectations are for further declines in mortgage rates and increasing prepayment risk. Last Thursday, Freddie Mac reported that 30-year fixed mortgage rates declined to 7.09%. Freddie's economist, Robert Van Order, suggested that next week's report could show a further decline in rates due to the Fed rate cut and economic indicators showing further slowing in the economy.

As of press time last week, mortgage spreads were about one basis point tighter down the line in 30s and 2 to 3 basis points stronger in the 15-year sector. As a result of convexity buying, swaps and agency spreads were both in 1 to 2 basis points on the day.

Also last week, Freddie Mac released prepayment reports for the month of January. As expected, discount coupons were slightly slower on seasonals and a lower daycount. Premiums were mixed with new vintages modestly faster, and seasoned issuers slower.

The upcoming Fannie Mae and Ginnie Mae reports are predicted to show slightly faster speeds down the line versus FHLMC. For discounts, there is a higher daycount, which will result in unchanged to slightly faster speeds. Premiums are predicted to show gains, particularly unseasoned vintages, as these reports will include the lows hit in mortgage rates and the high hit in the MBA's Refi Index in January. The February and March reports, however, will show the biggest impact of the declines that began in December.

Extension risk

in low coupons?

According to analysts at Bear Stearns, the composition of the upcoming supply of 6.5 and 7% coupons is radically different than what was being created in the refi wave of 1998. Back then, homeowners had been in their homes for about five years, giving newly formed pools a head start on the seasoning ramp.

This time around, however, today's refinancings consist of 2000 and 1999 vintages, which have no seasoning. As a result, these coupons are likely to season more slowly versus their 1998 vintage counterpart, Bear predicts. On this expectation, they believe there is more extension risk in new low coupon issues, and favor up-in-coupon

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