Mortgage players were squaring up positions last week and hunkering down for Y2K, with nary a trade passing across their screens.

"I've been out for two days and it took 30 seconds at most to catch up, because it's dead, dead, dead," said one MBS trader. "I don't think we'll do a single trade this week. The phones are not ringing."

Still, mortgages were said to be priced aggressively and well positioned for the new year. "Mortgages, the way they're priced today, according to my model, are five basis points rich to swaps, at least in the liquid securities," noted Dale Westhoff, managing director of the MBS department at Bear, Stearns & Co.

Traders seemed to be front-running the thought that spreads are going to tighten post-Y2K on increased demand and less supply, continuing an ongoing trend of spread tightening that began in August.

Since August, spreads tightened an average of 10 basis points per month, starting at about 180 over in August and hitting approximately 140 over in synthetic par by year-end.

Westhoff added that the market is at the deepest discount to par that observers have ever seen: 93% of the market is out of the money at discount, meaning that prepayments are very, very stable.

"The housing market is still relatively strong, and beginning in March and April, we will see an uptick in prepayment speeds," Westhoff said. "Rates can rally significantly, but you're not going to see a lot of volatility in prepayments because rates have been 100 basis points lower for a sustained period of time, and there is not a lot of demand out there for higher rates."

Agency Notes Become a Hedging Vehicle in 1999

Many observers are calling the establishment of the government-sponsored enterprises' benchmark program notes the single most important happening in the fixed-income sector this past year.

Fannie Mae, Freddie Mac and the Federal Home Loan Banks announced the issuance of their benchmark program notes, and across the spectrum, these bonds have quickly been picking up the slack of the diminishing Treasury supply.

Moreover, for the first year, all of these large benchmark issues have gone into the Lehman Brothers Aggregate Index, causing the index to grow substantially.

"Unlike prior years, when there were fewer deals, through the benchmark program, the percentage of agency notes in the index has grown, creating more liquidity there," said Michael Hoeh, senior portfolio manager at Dreyfus Corp. "It is now 10% of the index - it used to be 5% - and Treasurys shrank down to 32% of the index. Mortgage investors will now tend to hedge with agency notes more frequently, and this is a more efficient way of hedging credit and spread risk for mortgage investors."

JPM Takes The Lead

J.P. Morgan & Co. will be the first ones out of the chute for the new year on the commercial side, preparing an $800 million CMBS offering with $100 million of ABN Amro collateral and between $600 million and $700 million of its own.

This week, J.P. Morgan was said to be doing its roadshows for the deal, meeting up with investors and going through its loan documents.

Other early CMBS deals will be a floating-rate offering from Deutsche Bank Alex. Brown and another from Heller Financial, Prudential Securities Inc. and Residential Funding Corp.

Additionally, Salomon Smith Barney is currently preparing three deals for the new quarter, although none of them will be a conduit. Sources say that a floating-rate deal will occur for sure, and perhaps a no-lock transaction.

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