Since the beginning of June, the 10-year Treasury yield has dropped about 25 basis points. The decline has been primarily the result of a flight-to-quality related to civil unrest in the middle east; equity weakness on earnings and other headline news; and expectations that the Fed may not start raising rates until after September as the economic picture has not been strong.

The bottom line is that convexity and supply risk have increased and put tension on the mortgage market. Morgan Stanley estimates the cumulative convexity-related duration buying interest has jumped to $44 billion from $8.6 billion in 10-year swap equivalents. Still, mortgage-hedging activity remains muted. Lehman Brothers attributes this to increased volatility through callable issuance as well as greater impairment cushions for servicing portfolios. Lehman says it expects these factors to keep convexity activity less pronounced this time around.

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