Prior to the Federal Reserve Board announcement last Wednesday, mortgages saw good buying support as supply had slowed down to less than $2 billion per day from the previous week's $4 billion per day level. The supply-induced spread widening attracted investors, as did the prospect of a Fed rate cut and the return of the CMO bid. Buying flows were concentrated from current coupons to premium coupons in both 30- and 15-year MBS. The higher coupons benefited as alternatives to more typical money market investments, as well as managers employing barbell strategies.
Dwarfs also saw good buying interest as that sector has lagged 30s. Bear Stearns believes investors should take advantage of the underperformance or Dwarfs relative to 30s. Once rates back up, Bear says, 15-year MBS tend to outperform as the demand for extension protection heats up. At the same time, an increase in rates will lead to lower supply in this sector.