Extension risk was the watchword as the week started. Early week research from both Countrywide Securities and Barclays Capital, for example, highlighted the risk, saying that the mortgage market hadn't yet begun to reflect the significant extension risk. The analysts added too that the increase in interest rates could put further pressure on the housing sector as well as slow down prepayment speeds. Barclays noted that accounts were slowing their prepay models and lengthening durations to account for the effect of weak housing. This could lead to portfolios shedding duration, they said. They added that investors that were long duration in anticipation that the Federal Reserve would be cutting rates could be shifting their views in light of the recent data, and so start selling MBS.
The selling arrived on Thursday. When New York opened, the 10-year yield was above 5%, and prices steadily gave ground throughout the morning. The increase in yields was attributed to news of a surprise rate hike overnight in New Zealand and talk that Australia may be next. The steady rise in domestic interest rates recently has been due in part to higher global rates. Stocks had been steadily setting record highs despite the higher interest rates, but that was arrested last week, as well, when the Dow started heading lower on concerns about higher rates.