With refinancings projected to soar in the coming months, and speeds in some Ginnie Mae cohorts expected to outpace their conventional counterparts, investors are wondering where to put their money.

Pricing in the MBS market has already reflected the expected acceleration in speeds, sources said. The next issue, however, is what happens if rates rally?

"The only thing to remember is that if we rally from here there is not going to be much price upside in things like Ginnie Mae 6.5s or Ginnie 7s," said Peter Perrotti, a senior vice president at The Hartford Investment Management Co.

Perrotti said that in these cohorts investors could get relatively good carry versus short duration Treasurys, but are not going to get much price upside from there.

Therefore, on the margin, he prefers collateral because if rates back up, people would be trying to get the most out of their investments as implied volatility may rise.

On the carry front, 6.5s would fare a little better than 7s, while 6s will outperform both coupons as it would add duration. Following the Treasury curve, investors pick up yield as they add duration.

Perrotti remains positive on MBS. "Overall, we like the mortgage market on the margin even though there may be near-term cheapening," he said.

Into POs, out of IOs?

David Montano, head of mortgage research at JPMorgan Securities said that investors should consider moving out of IOs given the kind of refinancing activity on the horizon. The Trust IO market has held in very well relative to the previous refinancing wave in the fall.

One factor that has supported IOs is servicer selling of POs. This is beneficial to the IO market but detrimental to POs even with huge paydowns. Recently, servicers have reversed trends and begun to be net buyers of POs.

With prepayments in the IO market remaining high, IOs may be hit hard. POs, on the other hand, should provide a temporary haven given how low rates are. This would be especially attractive for people who believe rates will remain low.

Aside from significant paydowns in the PO sector, convexity is decent and the sector out-yields most of the mortgage market.

"I expect that it would be a strong performing sector over the next month or two especially as paydowns come in," said Montano

Aside from POs, Montano suggests going into 30-year 6s and 15-year paper 5.5% (as fixed-rate supply is likely to be low given the high level of ARM originations).

Extension risk

In his market commentary, Montano said that mortgage durations have shortened to the point where extension is currently the biggest risk in the market.

If mortgages sell off, their duration would lengthen. With most of the market pretty much in the money - as practically everyone has an incentive to refi - callability risk no longer becomes the issue because the market has already priced that in.

This would mean that for a 25 basis point move, the decline in price is much larger than the increase in price.

Hartford's Perrotti said that investors are generally cognizant of the risks in a rate back-up. However, "In the near term, there does not seem any reason for rates to back up quickly," he said. "I think we are going to see quick speeds for a little while."

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