Good Morning. Its Friday and Flight to Quality Allocations Are Fleeing the Bond Market.

After touching our long standing 3.71% recovery rally target yesterday, long-term bullish trading technicals are being outweighed by short-term tactical biases today. Triggered by what seems like fundamentally positive news out of Greece, the bond market is losing a portion of its originator friendly "flight to quality" allocation this morning. (read "seems" as there is a complete lack of details on this event, which is FAR from over)

While you were sleeping Greece asked the EU and the IMF to activate a €45 billion  ($60.5 billion) rescue package to help shore up short-term funding needs.  Speaking on national TV, Greece Prime Minister George Papandreou said "It is imperative that we ask for the activation of the mechanism".

European and US equity markets reacted well to the news. European and US bond markets did not.  Mortgage rates will move higher as a result.

The 3.625% coupon bearing 10 year TSY note is -0-13 at 98-13 yielding 3.821%. This is what we consider a firm layer of support for our "rate sheet influential" MBS big brother. If 3.82% fails to attract buyer demand, expect 10s to tick up to 3.85%

The FN 4.5 is -0-07 at 100 the dollar yielding 4.507%. The secondary market current coupon is 4.507% The current coupon yield is 69.2 basis points over the 10yr TSY note yield and 68.8 bps over the 10yr IRS (yes the 10yr swap spread was negative again this morning).

Thinking in terms of the mortgage market and only the mortgage market....

Mortgages got their butt whipped by TSYs this week...meaning MBS yields failed to rally as much as TSY yields. That yield spread widening seems to have stopped out yesterday afternoon when the current coupon moved as wide as 71bps over the 10yr TSY note, this relative cheapening brought out bargain buyers. I would anticipate mortgages to extend their outperformance of TSYs as we head into another round of TSY auction supply next week. Furthermore, lower MBS dollar prices will attract demand from real money accounts (eg banks), which supports the argument to "buy the basis" (the theory that MBS yields will outperform benchmark yields). If this does turn out to be the case, we might consider PHASE 2 of post-Fed MBS buying program to be complete with relative valuation support confirmed at+ 71bps/10s. The wild card is of course, will lenders be hedging against higher rates (locking in now vs. when rates are higher) and how will the street react. Buy at the wides (+70/10s), sell at the tights (+60bps/10s)....yawn range trade.

HERE IS A YIELD SPREAD REFRESHER

Unfortunately the direction of mortgage rates is not totally dependent on yield spread levels. We have general guidance giver (TSYs) directionality to contend with as well. This means if benchmark TSY yields continue to rise, mortgage rates will suffer, regardless of the fact that we do not believe MBS yields will rise as fast as TSY yields.

For now, in the context of our "PLAY THE RANGE UNTIL THE RANGE PLAYS YOU" strategy, we have learned that the aggressive side of our spring range is a 10 year note trading near 3.71%. What we do not know is where we will ultimately find support in a sell off. Our first pivot is 3.82% followed by 3.85% then 3.88%...after that our eyes will be wondering toward a test of 4.00%.

With that mind, when you consider the fact that the recent development in the Greek saga is by no means the end of the story, it is a bit hard to provide guidance on just how far rates will rise and how long it will take to recover. It is afterall a Friday and participation in this sell off has been light....volume is low!

REPRICES FOR THE BETTER AROUND 100-10

REPRICES FOR THE WORSE WILL BE BAKED INTO YOUR FIRST RATE SHEET RUN