The week saw better MBS buying overall as the market settled down following a sell-off related to the stronger-than-expected Chicago PMI and ISM Index that spurred the 10-year Treasury yield to 4.32% at last Monday's close from 4.19% on the previous Thursday. The backup resulted in heavy selling - particularly in the 5% coupon - from hedge funds and servicers shedding duration. The sector started to recover Tuesday as investors took advantage of the recent spread widening and set up for Friday's non-farm payrolls report. Trades of note included the up-in-coupon into 5.5s and 6s from servicers, and some short covering in 5s from money managers and hedge funds. Real money and overseas buyers also took advantage of the cheaper price levels. Originator selling, meanwhile, held to about $1 billion per day last week, down from around $1.5 billion in the previous week.

Analysts remain mixed on the sector. For example, JPMorgan Securities analysts believe mortgages are likely to provide flat to marginally negative excess returns at modest volatility levels. The near-term outlook is for even worse performance if the recent range is broken. UBS, on the other hand, is holding with its mortgage overweight. Analysts said cash-heavy investors taking advantage of the higher yields outweighed recent servicer selling, a pattern expected to continue. UBS prefers higher coupons, and while this trade has done well recently, UBS analysts believe it can go further. Countrywide Securities is also constructive on the sector, as long as the 10-year yield doesn't "break decisively above 4.35%." Breaking the threshold raises fears of extension risk and selling from servicers.

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