Despite concerns regarding convexity and prepayment risk, the mortgage sector began to see good buying by Thursday of last week. The sector is seen as cheap on a fixed-volume basis by some, and the primary participants have been money managers, banks, CMO dealers and arb accounts, sources say.

While originator selling was somewhat modest towards the end of the week, over the near term it is expected to remain heavy due to the low level of mortgage rates.

According to Freddie Mac, fixed mortgage rates declined further last week, with the 30-year rate now at the magic 7% level, down from 7.03% the week prior. Rates were last this low at the beginning of April. Fifteen-year fixed mortgage rates fell four basis points to 6.54% while one-year ARM rates increased to 5.77% from 5.72%.

At this level, refis should hold steady to slightly higher over the near-term. As a result, speeds into the fall should show modest gains, particularly in the new-premium issues. For example, Bear Stearns expects that after falling in July and August, speeds on new FNMA 7.5s should reverse and climb back to the 40 CPR area and 8s back up to low 50 CPRs.

Treasurys suffered again late last week, and mortgages in part benefited, as well as corporates. Profit-taking in Treasurys was the order of the day last Thursday, and despite increasing prepayment risk in MBS, investors began to see value in the cheaper paper.

At the end of business on August 2, spreads tightened two to four basis points in 30s and were four to six basis points firmer in 15s. While last Wednesday saw heavy originator selling of about $1 billion, Thursday saw more modest accounts.

But sources say this is just a brief reprieve, as heavy mortgage banker selling is likely to continue as mortgage rates head even lower. Last week, mortgages outperformed hedge ratios and beat swaps and agency spreads, which were essentially flat on the day.

Last week's backup in Treasurys sent 10-year yields about nine basis points higher and brought a pause to convexity buying. Longer term, however, this latest drop is predicted to keep prepayment speeds higher into September and October, a period when speeds are generally slowing.

The July report, due out this Tuesday, is expected to see slowing of about 5-10%, with some additional slowing in the August report. Based on the recent gains in the MBA Refi Index, September and October speeds will be closer to June levels on unseasoned premiums. How rates respond after the most recent employment reports (due out last Friday), the upcoming refunding, and economic performance will determine whether speeds after October will start to come off.

In other news, Fannie Mae repurchased $2 billion of the 5.125% of February 2004. Four issues were targeted, but FNMA only repurchased the one leaving $10.67 billion outstanding. Since announcing its buyback program in March, FNMA has repurchased a total of $4.932 billion.

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