Mortgages have recently performed poorly. However, outlook for relatively stable rates and declining implied volatilities over the intermediate term continue to suggest a modest overweight stance in mortgages. In agency passthroughs, add negative convexity and extend duration vs. benchmarks to pick up yield. Within passthroughs, overweight current- and cusp-coupons. For IO investors, IO and cusp-coupon pass-through combinations offer even better projected return advantages and the potential to benefit from advantageous financing on the passthroughs. TBAs appear compelling versus seasoned issues. In agency CMOs, recommends short, less than two-year in WAL, PACs that offer WAL stability in addition to attractive yields.

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