Mortgages continued to see strong two-way flows last week, as money managers, in particular, remained strong buyers. Originator selling remained generally light at about $4 billion. There was also profit taking, notably from banks, on the tighter spreads. Spread tightening ranged from 8 basis points in conventional 6s to 3 basis points in 7.5s, while 8s and higher coupons were wider. Discounts and current coupons were supported also by roll activity related to 48-hour notification on 30-year conventionals that began on Thursday.

Overall, spreads are expected to be tighter throughout the quarter. Goldman Sachs, in fact, "believes that mortgages will be one of the leading rate of return performers for the first half of the year." Most firms on the Street are now overweight the sector. Reasons include declining volatility, lower dollar prices, historically wide spreads, excellent carry, and slowing prepayments and supply.

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