After a week of relative quietude via limited data and events that had many participants on vacation for the holiday-shortened week, headlines quickly heated back up to roil the mortgage market.

In a testimony on Tuesday from U.S. Department of Housing and Urban Development Secretary Shaun Donovan before the Senate Banking Committee, he noted the Federal Housing Administration (FHA) would be making changes to its streamline refinancing program to encourage more widespread use and that "in addition to taking steps to make these refinance loans more widely available, FHA is working on adjusting the premium structure for all streamline refinance transactions that are refinancing FHA loans endorsed on or before May 31, 2009, to further incentivize refinance activity. These changes will ensure that borrowers benefit from a net reduction in their overall mortgage payment while still ensuring FHA has the resources to pay any necessary claims."

Higher coupon GNMA/FNMA swaps, of course, dropped sharply with the 5.0 swap, for example, backing up from 2-18+ as of Friday, Feb. 24, to 2-11+ by Tuesday's close and 5.5s also moving from 2-16 to 2-08 over this period. GNMA/FNMA swaps saw some recovery in subsequent sessions with 5.5s improved to 2-12 by Friday helped, in part, by month-end index buying, as well as, a sharp sell-off in Treasuries on Wednesday and Thursday that attracted better overseas interest in Ginnies on the higher yield levels.

The midweek sell-off in Treasuries was on a combination of better-than-expected economic news (4Q11 GDP and Chicago PMI) and testimony from Chairman Ben Bernanke before the House Financial Services Committee, further supported by the latest Beige Book results, that investors perceived as reducing odds for further stimulus. His remarks acknowledged growth in the economy along with "positive developments in the labor market". He stated that "the decline in the unemployment rate over the past year has been somewhat more rapid than might have been expected, given that the economy appears to have been growing during that time frame at or below its longer-term trend."

The Beige Book was in line with Bernanke's remarks with 11 Districts reporting some level of expansion with only New York reporting a slower pace. The report also noted that hiring had increased slightly across several Districts.

Following Bernanke's remarks and market reaction, Credit Suisse analysts said that market pricing of QE3 probability had declined to under 20%. This is down from around 40% following the FOMC statement in late January which dropped to 25% after release of the FOMC minutes.

Fast money, in particular, was noted selling in lower coupons as they reduced their exposure to QE3 trades. Further weighing on mortgages was originator selling that picked up in the sell-off to levels closer to $2.0 billion. This becomes especially burdensome to the markets when the Federal Reserve's daily average buying is $1.2 billion, as they reported in their latest weekly release.

The supply/demand imbalance, however, is temporary and longer-term technicals remain supportive. In fact, the drop in price and increase in the 10-year note yield to over 2.0% did draw in a bit of buying from banks and money managers.

As the week closed out, investors had less appetite for risk and Treasuries rallied. Technicals opened supportive with very little supply against better Fed and real money buying; however, a pickup in profit taking and selling from originators turned spreads in production coupons flat to the curve and swaps by close, while higher coupons were wider by as much as 1/8 point (5.0s).

In other market activity, 15s outperformed 30s in higher coupons over the week, while FG/FNs moved higher on real money buying and a brief mid-week pause from Treasury BWICs. Speaking of the Treasury, its mortgage portfolio as of the end of February had just over $5.0 left to sell and it's estimated the portfolio will be wound down by mid-March.

Selling from mortgage bankers over the week averaged $1.8 billion per day, up from $1.6 billion in the prior week. MBS volume as measured through Tradeweb averaged 108% versus 72% previously. The 30-year current coupon yield rose to 2.90% from 2.86% with the spread to 10-year notes a basis point wider to 89.

For the month of February, excess return versus Treasuries on Barclays Capital's MBS Index was 37 basis points compared to 24 for ABS, 152 for CMBS and 157 for Corporates. Year-to-date tallies are 50 basis poins MBS, 109 basis pointss ABS, 318 basis points for CMBS, and 324 basis points for Corporates. The results illustrate the increasing risk on mentality of the market so far in 2012.

Prepayment Outlook

Speeds on 30-year MBS are currently projected to increase around 6%-7% on average in February from January. The gain is attributed to a combination of seasonals, Home Affordable Refinance Program as well as the rush by originators to close loans before the 10 basis point guaranty-fee increase goes into effect on April 1.

Net issuance is projected to be more or less flat based on gross issuance of $111 billion and estimated paydowns of $110 billion. The February report will be Tuesday afternoon.

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