Last week mortgages benefited from light supply and strong demand from a variety of sources, most notably banks. The previous week's selloff cheapened mortgages up enough to encourage investors to move back into the sector. While mortgages are still on the rich side, the favorable technicals can't be ignored. Also helping has been declining volatility.
As mentioned, the positive tone in the market was set by the noticeable increase in bank activity - finally! JPMorgan says it expects "accelerating demand as bank Treasury portfolios assess the changing market conditions (and improving carry in mortgages as the market sells off and the curve steepens)." At the same time, the technical story in mortgages remains alive and kicking. Originator selling remains fairly light and street inventories are also said to be light. According to Lehman Brothers, carry seems to have potential to dominate again with the Fed anticipated to be on hold through most of 2004. The firm also expects a continued steep yield curve, and the bond market settling into a range.