After a stellar 2006, mortgages are off to a strong start in 2007. According to Lehman Brothers, the MBS Index outperformed Treasurys by 122 basis points in 2006 compared with negative 37 basis points in 2005. The sector also performed well versus ABS and CMBS, which provided excess returns of 87 and 137 basis points, respectively, last year. So far in 2007, the MBS Index is up 15 basis points compared with two and four basis points over Treasurys for ABS and CMBS.

Contributing to the gains has been active buying that was stimulated by the end-of-year sell off that moved the 10-year Treasury yield from 4.623% on the Friday before Christmas to 4.708% on the last day of trading for the year. Fast money has been a strong buyer, taking advantage of the Asian holidays to add on expectations of strong buying when Asian investors return. Servicers have also been active, focusing particularly on 5% coupons. Real money, including banks, has been a brisk investor at these higher levels, interested mostly in 5.5s. Meanwhile, Asian buyers were relatively quiet as the region had extended New Year's holidays.

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