December started off with a sharp rally on Monday as investor anxiety picked up over the state of the subprime and credit markets, as well as the growing odds of a 50-basis-point cut in the funds rate. The jitters were brought on in part by a press conference from Treasury Secretary Henry Paulson talking about a plan he is working on with large banks designed to help subprime borrowers, coupled with further gains in Libor.

The 10-year Treasury soared 20 ticks higher on the day, sending the yield to 3.893% and 2s10s curve six basis points steeper to 99 basis points. There was heavy volume in mortgages with servicers buying 5s outright and moving down in coupon from 6s and 5.5s. FNMA 5% coupons were up 11/32nds on Monday. Other investor flows were mixed, though overseas buyers were reportedly more active. Adding to mortgage woes was the weakening in dollar rolls as a result of the higher cost of funds.

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