Despite the increasing risks in the mortgage sector, mortgages have held up well. Spreads in currents and discounts have widened five to six basis points over the Wednesday-to-Wednesday period, while higher coupons have weakened eight to 10 basis points on heightened prepayment concerns. Supply has picked up and is running at about $1 billion per day, with $300 to $500 million in 15s. The supply, however, has been absorbed by active buying from hedge funds, money managers and arbitrage accounts.

What is continuing to support mortgages are the strong rolls, the headline and credit risk issues in corporates, and so far, limited convexity buying in Treasuries. This could deteriorate rapidly, however, if Treasuries rally to 4.95% as convexity hedging would be triggered, says Deutsche Bank's Alec Crawford.

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