Both upper and lower coupons had their days in the sun this week. Over Monday and Tuesday it was lower coupons that outperformed; over Wednesday and Thursday it was up in coupon that led, and on Friday into mid-day the entire stack was doing well.

After a supply deluge that totaled around $8 billion over Thursday and Friday as September closed out, money managers stepped up to the plate at the start of the week to take advantage of the supply-induced widening. They were also selling higher coupons and moving down in coupon on nervousness ahead of Thursday's September prepayment reports.

At the same time, mortgage banker supply returned to its normal area of $2.0 billion per day, and with the Federal Reserve's $4.0 billion per day average appetite technicals were very supportive down in coupon. It led to the coupon stack "compressing" with prices higher over the first two days by 12+ and 5+ ticks on FNCL 3.0% and 3.5% coupons, while 4.5s through 5.5s were flat to 5+ ticks lower.

Lower coupon 3.5s and 4s, however, got a wake-up call on Wednesday when the Mortgage Bankers Association's mortgage application activity survey reported a nearly 20% jump in its Refi Index to 5888, its highest level since April 2009 as mortgage rates set new lows. Further, the surge was seen as "rate-driven" as the average size of the loans being refinanced rose 11% from the prior month.

These coupons were hit hard as a result with selling from real and fast money with prices down 1/2 and 3/8 of a point by Thursday's 3:00 pm marks from Tuesday. Investors moved up in coupon due to the increased prepayment risk that looms beginning as soon as the October prepayment report (released in November). Meanwhile, 3.0% coupons were avoided on increased supply over mid-week.

The entire stack was strongly supported on Friday. Higher coupons were benefiting from release of the September prepayment reports with speeds slowing as expected and an outlook that speeds on the HARP cohorts have likely peaked. While lower coupons did not slow as much in September which was an indication of increased capacity at the mortgage bankers, the recent cheapening along with a sharp sell-off following a drop in the unemployment rate to 7.8% from 8.1% with strong revisions to NFP totaling 86k for August and July drew in overseas, domestic real money, fast money, and the Fed. At mid-day, the 10-year note was down 14 ticks, while 30-year FNMAs ranged from -3+ ticks on 3.0s to +3 ticks on 5.5s. Spreads were 2-3 ticks tighter in the belly, while the wings were around 1/8 point firmer.

The Fed, of course, was a steady buyer through it all. Their latest report for the week ending October 3 showed an equivalent of $3.9 billion per day in buying which more than covered mortgage banker supply that averaged $2.9 billion. Of particular interest, they bought a small amount of 30-year 2.5% coupons for December, while the percentage of buying in GNMAs and 15-years increased.

In other mortgage related activity, dollar rolls were mostly lower on early rolling from money managers, supply and/or prepayment risks; 15s outperformed 30s in the lower half of the coupon stack with some benefit as well from a steeper yield curve, while GN/FNs were lower with the exception of the 3.0 swap. Specified trading was active with several billions in originator BWICs as Class A looms next week. Despite the supply, payups were firmer on a combination of strong demand for call protected paper, as well as, weaker rolls.

Between the supply, prepayment reports and outlook, and late week sell-off, volume remained elevated in MBS. Tradeweb averaged 130% for the week through Thursday which was similar to last week. Through the first four days of October, excess return to Treasuries on Barclays MBS Index was -11 basis points; the 30-year current coupon yield was down eight basis points to 2.07% with the spread to 10-year notes tighter by 11 basis points to +41.


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