Mortgage flows were steady both ways throughout the week. Originator selling remained within normal levels with the exception of Tuesday. The day saw nearly $2.5 billion. Supply managed to pressure spreads wider; however, this attracted money managers, which made the grind even tighter. Also providing support for the sector was a strong CMO bid, especially in 15-year collateral. Over the Wednesday-to-Wednesday period, spreads were one basis point wider in 30-year Fannie Mae 5.5s, where most of the supply was; and nine and three basis points tighter in 6s and 6.5s, respectively. In 15s, spreads were minus six basis points for dwarf 5s and 5.5s.

For now, extension risk has moved to the back burner and the technical and carry story are back in the forefront. But extension remains the greatest risk in the mortgage market. Analysts from Lehman Brothers warn of the potential of a significant change in the composition and convexity profile of the MBS Index over the next year as a result of the heavy paydowns and increasing representation of lower coupons in the index. They predict the duration of the index to extend by one-year, even if rates do not change. "Given the current size of the index, this amount of extension corresponds to $400 billion 10-year equivalents," say researchers from Lehman.

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