It is currently a difficult environment for mortgages as the market tries to find a new range and investors try to gauge potential convexity selling risks. In this situation, mortgages in general will strengthen in a rally and weaken in a sell-off. This was how mortgages behaved in the early part of last week. With the market holding stable to slightly higher, real money and relative value accounts took advantage of the sector's recent cheapening and lack of servicer selling to add bonds.

Mortgages, however, didn't go along with the new playbook when the market began to rally strongly Wednesday and in early trading on Thursday on the negative General Motors Corp. news. The sharp move higher in prices encouraged many participants to move to the sidelines or take profits on the recent gains. In comments from JPMorgan Securities, analysts suggested the MBS response might be in sympathy with the credit spread widening. The market instability, along with the looming Federal Open Market Committee meeting and upcoming PPI and CPI reports, may have also contributed to the limited participation.

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