Benchmark yields are testing their overnight highs and "rate sheet influential" MBS prices are teetering on new intraday lows. While not yet in reprice for the worse territory we should caution that this directional move may continue as we approach the 1pm $32 billion 3-year Treasury note auction. Liquidity is lacking and trading volume is not robust. This creates a volatile environment where gappy moves are more possible.

A bear flattener is when yields in the short end of the yield curve are rising faster than yields in the long end of the yield curve. A few reasons can be cited for this "bear flattener". First and foremost, China raised interest rates last night for the second time in just over six weeks. This pressures shorter dated benchmark Treasury yields higher as investors account for a larger global inflation premium. This would relate to the Federal Reserve raising the Fed Fund's Rate. Another reason for the "bear flattener" is pending Treasury auction supply. Treasury will auction $32 billion 3 year notes at 1pm today. With supply focused in the short end of the yield curve, traders are looking to build in whatever concessions they can to cheapen the issue before they buy it. So while "rate sheet influential" Treasury yields are still moving higher today, they are outperforming the short end of the yield curve.

If we were to base our intraday reprice targets off current indications, we'd be looking for lenders to consider reprices for the worse as the FNCL 4.5 approached 100-20. Reprices for the better would become more likely as the FNCL 4.5 moved closer to 101-06. In terms of resistance and support, breaking back into the 101 price handle will present a challenge while FNCL 4.5s find support around 100-22.

Faced with high unemployment and strategic default rates, mortgage investors are more focused than ever before on achieving greater transparency into the collateral health of non-agency mortgage-backed securities. While there has been some preliminary research on payment and default hierarchy, Equifax Capital Markets has taken a unique approach to analyzing borrower behavior. In a recent study, Equifax defined a new metric – default distance – which provides strategic insight into default timing. Default distance is the number of months between the default of a revolving debt and the first occurrence of foreclosure (as reported by MBA status) in a non-agency securitized mortgage. A positive number means that a borrower defaulted on a revolving debt first while a negative number indicates that the borrower defaulted on their mortgage loan first.

Key Quotes from Lacker's Speech: "All in all, then, I expect noticeably stronger growth in overall activity this year than last"...."This generally positive assessment is complemented by the benign outlook for inflation."......"The most striking feature of this recovery is that until recently it has been relatively slow compared to past recoveries, particularly those following the two other severe recessions of the past 60 years – the recessions of 1973-75 and 1981-82."...."Beyond this coming year, the configuration of fiscal policies could have a significant bearing on growth prospects. We have a serious, long-term mismatch between the trajectories of federal spending and taxes"...."The distinct improvement in the economic outlook since the program was initiated suggests taking that re-evaluation (QEII) quite seriously. That re-evaluation will be challenging, because inflation is capable of accelerating, even if the level of economic activity has not yet returned to pre-recession trend"

(Reuters) - China raised interest rates on Tuesday for the second time in just over six weeks, intensifying a battle against stubbornly high inflation that threatens to unsettle global markets. The timing was a surprise, coming on the final day of China's Lunar New Year holiday, but investors have long expected more monetary tightening as Beijing struggles to rein in price pressures and ward off a property bubble. Benchmark one-year deposit rates will be lifted by 25 basis points to 3 percent, while one-year lending rates will also be raised by 25 basis points to 6.06 percent, the People's Bank of China said. The changes go into effect on Wednesday. Although annual inflation slowed in December, analysts polled by Reuters expect it to have picked up to 5.3 percent last month, the fastest pace in more than two years, on the back of soaring food prices.

The National Federation of Independent Business Index of Small Business Optimism rose 1.5 points in January, a modest increase, opening the new year with a reading of 94.1. The slight overall uptick in optimism might have been higher, but was blunted by small business owners’ skepticism about the future and continued hesitancy to spend and hire. Weak sales is still the most frequently cited top business problem. However, price-cutting is fading, and inventory-adjustments to match lower consumer spending appear to be reaching a conclusion. “Manufacturing and exporting are leading the recovery—industries and activities that are not labor intensive—while construction, an industry historically dominated by small firms, remains depressed,” said NFIB chief economist Bill Dunkelberg. “While recent political rhetoric favors small business, it is belied by the actions of policy makers whose new policies and activities almost exclusively support big businesses. While the economy is moving forward, albeit at a snail’s pace, it is not nearly fast enough to dramatically improve the unemployment situation, which continues to languish.”