A strong sell-off last Monday on inflation concerns sent the mortgage market reeling as the 10-year Treasury yield surged past 4.30% and closed in on 4.40%. The sell-off was fueled in part by mortgage participants lengthening their portfolio duration as rates rose. MBS originator selling picked up and averaged around $1.5 billion per day. Servicers, not surprisingly, were better sellers as well. Not inspiring confidence either were Fannie Mae's accounting and capital surplus issues (see related story on p.17). Traditionally, the GSEs have been seen as a backstop bid, but that is less likely given Fannie's need to meet a 30% capital surplus requirement by Sept. 30.

While spreads widened dramatically over the first half of the week, real money investors were not confident to step out with the February employment report looming on Friday, after press time. By mid-week there was some interest from fast money and dealers as the market's tone improved - boosted by a slowed servicer selling. If Friday's report comes in as expected or weaker, the sector is expected to see strong support as the range holds. If the report is stronger than expected, mortgages are expected to see better selling as a result of re-balancing, higher volatility and extension risk fears.

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