Prices finally eased back with the 10-year note yield rising from 1.85% last Friday to over 2.0% by mid-afternoon today as markets added risk on a break from adverse headlines out of Europe.

The result of the sell-off, of course, was a pickup in mortgage banker supply to a daily average of $1.9 billion, mostly 3.5s, from $1.7 billion last week.

As yields began backing up into mid-week and supply increasing, investors headed to the sidelines or took profits in the case of money managers. Thursday, however, and continuing Friday, investors including banks, money managers, insurance companies and hedge funds began emerging to take advantage of the lower prices and supply-induced widening across a good portion of the coupon stack.

The Fed, of course, remained present and accounted for in 3.5s and 4.0s. However, lower paydowns were available for reinvestment resulting from slower prepayments in December while supply moved higher, the Fed was only able to cover about 68% of it compared to between 90% and over 100% in the previous six weeks. For the week ended Jan. 18, the Fed bought $5.35 billion or $1.3 billion per day.

Meanwhile, Freddie Mac reported 30-year fixed mortgage rates slipped to a new low of 3.88% this week which suggests elevated supply is likely to continue. Mortgage banker selling over the past three weeks has averaged between $1.7 and $1.9 billion per day compared to between $1.0 and $1.5 billion over October and into December.

Meanwhile, based on less than $20 billion left in their current period of MBS purchases through Feb 10, daily average buying from the Federal Reserve Bank of New York is estimated at $1.2 billion. At this level, the Fed coverage looks to be between 71% and 63%. This might offer investors with some attractive entry opportunities as these buyers might require some additional spread to take down the excess supply.

In other mortgage related activity, specified trading was mixed with dollar roll levels leading some to sell versus TBAs, while others sought out call protected paper as a result of increasing prepayment risk.

GNMA/FNMAs were lower, partly due to the calendar flip to February, as well as limited overseas participation in GNMAs.

Meanwhile, 15s outperformed 30s as they benefited from the steeper curve (2s10s moved from +162.6 as of last Friday's close to around +178 by mid-afternoon today).

This week's sell-off led to higher volume with Tradeweb averaging 115% through Thursday compared to 107% last week. Month-to-date excess return to Treasurys on Barclays Capital's MBS Index was at +28 basis points, essentially flat over the week from last Friday.

CMBS increased to +123 from +86 and Corporates to +93 from +61. The 30-year current coupon yield rose to 2.97% from 2.87% with the spread to 10-year notes tighter to the mid-90s from +102.

Prepayment Outlook

Prepayment speeds currently are projected to slow around 3 percent on average for 30-year conventionals and GNMAs in IFR Markets' sample. For FNMAs and FHLMC Golds, 5.0% and lower coupons are predicted to record larger percentage declines than higher coupons with 6s and above seen flat to slightly faster on average from December.

The longer processing times associated with the credit impaired coupons, along with some Home Affordable Refinance Program or HARP 2.0 refis, are influences in the fuller coupons. Paydowns currently are estimated at $108 billion; gross issuance stands at $66 billion month-to-date.

In February and March, prepayments are expected to start turning higher. Barclays analysts think that speeds on 2010 3.5s through 4.5s could reach a new high in the February report, which will be released in March, because of the recent decline in mortgage rates to new record lows. These coupons and vintage hit highs in November at 13.5, 24.2 and 24.9 CPR, respectively.

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