The week in mortgages was described as "slow", "light", "exhausted", and "apathetic". This statement is supported by Tradeweb's volume which averaged 87% for the week through Thursday, down further from even last week's limited 93%.

While year-end and the holidays were a factor in the decrease, higher prices and lower yields resulting from continued risk aversion associated with concerns over the European Union crisis continued to play a major role and generally overrode some favorable economic reports.

MBS investors are more resistant at a 10-year note yield below 2.0% and by mid-day Friday it was hovering in the low 1.80% area from 2.056% as of last Friday's close, while the 30-year current coupon yield was below 3.10% from 3.15% to 3.20% earlier in December.

The Federal Reserve remained the most supportive participant in the sector, averaging $1.51 billion per day based on its latest weekly report. Meanwhile, selling from mortgage bankers averaged $1.3 billion, which provided a very favorable demand/supply dynamic.

While originator supply appeared limited on an average basis, it did tick higher from a $1.0 billion per day average earlier in the week to $1.5 billion in the latter half. Reports are that rate locks were high toward the end of the week as mortgage rates tumbled back to match record lows. This indicates more supply is looming.

The other "regulars" – money managers and hedge funds – were "two-way", which was another repeated word this week. Flows were primarily focused in lower coupons on the higher prices and the over 20 basis points flattening in the 2s/10s curve.

However, up in coupon, especially 5.5s and 6.0s, had interest on Thursday that was reversed out on Friday on worries that Bank of America might become more active in Home Affordable Refinance Program. In other activity, 4.5 and higher rolls were slightly lower, 15s lagged 30s on the flatter curve, GNMAs/FNMAs were lower, while trading in specifieds was relatively quiet.

One highlight this week was the last Federal Open Market Committee meeting for the year. It was expected to be an uneventful affair that did not tackle a third round of quantitative easing – and that is exactly what it was.

The statement, however, did note "Strains in global financial markets continue to pose significant downside risks to the economic outlook."

Nomura Securities and Wells Fargo analysts have said in research that one factor for engaging in a third round of quantitative easing would be risks in the eurozone that threaten U.S. growth in the near term.

Specifically, Wells Fargo analysts suggested that the Fed might take preemptive action to offset the potential negative effects of a eurozone default or inability for leaders to agree to an acceptable solution.

The third round of quantitative easing remains on the minds of MBS participants and this is providing a backstop for spread widening. Deutsche Bank Securities analysts said the market has priced in at least half of the tightening associated with additional MBS purchases via a third quantitative easing round, although there is some room to tighten on the news.

Economists at IFR Markets believe it is more likely that the Federal Open Market Committee (FOMC) would announce the third round during a two-day meeting in to allow for more discussion as well as to take advantage of the post-FOMC press conference to better telegraph its message. The next two-day meeting is January 24-25 and then April 24-25. With this in mind, the markets will be paying close attention in the weeks ahead to events in the EU as well as to U.S. economic data.

MBS performance relative to Treasurys deteriorated over the week with month-to-date excess return on Barclays Capital's index at +10 basis points from +25 basis points through December 9.

The sector lags CMBS (41 basis points), Corporates (40 basis points), but leads ABS (negative 10 basis points). The 30-year current coupon spread to 10-year notes widened to 114 basis points from 109 and to 98 from 96 versus 10-year swaps.

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