The New Year rally in mortgages petered out last week as the sector came under strong selling pressure. After gaining 25 basis points in excess return, according to Lehman Brothers' MBS Index in the first four days of trading, last week saw 12 basis points of erosion in the first half of the week. Month to date through Jan. 10, the MBS Index is up 13 basis points.

Factors encouraging the selling include the backup in yields on stronger-than-expected economic data, limited Asian support so far this year, and a widening in swap spreads due, in part, to deal-related hedge unwinds. Treasury yields have steadily backed up since the sharp gains in December's employment figures reported Jan. 5. Prior to the release, the 10-year Treasury yield had rallied to 4.618% from 4.708% as of the close of 2006. The yield was back above 4.70% following the large drop in initial claims on Thursday. Initial claims declined by 29,000 to 299,000 in the week ending Jan. 6. IFR Global Markets' economists note that while the data continues to show volatility, a number below the 300,000 mark might point to a tight labor market. Of course, this added to inflation concerns. In addition, last week's trade data and wholesale trade numbers were expected to lead to upward revisions to economists' estimates for the fourth quarter GDP. The outlook for decent economic growth further reduced the odds that the Federal Reserve will ease in the foreseeable future.

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