Mortgages struggled early last week on the lofty price levels and increased concern of 5.5s breaching $102. The week saw better selling from a variety of accounts including relative value, fast money and overseas accounts. In addition, originators were average to slightly above average sellers on the week. Towards the latter part of the week, the cheapening started drawing investors back, particularly in 5.5s, as prices moved near the middle of their range. Other areas of the coupon stack benefited as well, for various reasons. For example, 4.5s saw strong buying from dealers last Wednesday as they covered shorts. In comments from JPMorgan Securities, analysts believe the Street is significantly short 4.5s and is likely to remain that way for the near term. Meanwhile, 5s and 5.5s were gaining support from CMO dealer related buying; while higher coupons gained from the pricing of a $2.5 billion Gold 6.0 trust.

In general, the mortgage outlook remains favorable, with spreads expected to hold firm due to the low volatility, declining fixed rate supply, and continued overseas demand. Also noted is a sharp drop in dealer positions. A JPMorgan report stated dealer positions in January have dropped sharply and net holdings are at negative levels for the first time in two years. "The Street is clearly trading mortgages from the short side in a period of little supply," which are overwhelming positive technicals, analysts report.

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