The pain trade is playing out in the long end of the yield curve but "rate sheet influential" MBS coupons are displaying the same resiliency they exhibited yesterday.

The 2s/10s curve is 7bps steeper, now 220bps wide, and the 2s/30s curve is 8bps steeper at 362bps across. The benchmark 10 year note yield is -15/32 at 100-18 yielding 2.56%, 5.4bps higher on the day. Half way through the session trading volume in the 10yr TSY futures contract has just about become the busiest day of the week with 1.22 million cars already moved.  Most of this volume hit screens after 830am data and Bernanke's comments weren't supportive enough to stop follow through selling, which means if we see a recovery rally in benchmarks, 2.46% will be tough to break. I view this move as a short term tactical play by dealers who are looking to catch the majority of the market off-guard as punishment for the force feeding they experienced at TSY auctions this week.

Mortgages tend to perform well when benchmarks start selling in size. This is obvious over the past two days as favorable supply/demand technicals (originators don't need to hedge right now, they should be buying back some hedges actually) are adding a layer of durability to "rate sheet influential" MBS coupons.

The FNCL 3.5 is -0-03 at 100-19. The FNCL 4.0 is -0-03 at 103-04. I've got the production coupon marked at 3.446%. Yield spreads are at their tights of the day. Trading volume is below average.

In the chart below you can see that 3.5s are coming down from their QE induced sugar high and are about to reenter "THE RANGE". FNCL 3.5s haven't committed to moving back into that range yet but we're right at the intersection of trend channel support and the outer limits of the range.

Regardless of the relative strength of "rate sheet influential" MBS coupons, benchmark yields are trending toward my next inflection point, 2.604% and MBS price can only take so much pressure. If 10s retest 2.604%, MBS prices will fall further and we would see reprices for the worse.

If you are floating a deal that needs to be locked up soon, beware, until the Fed provides a bit more clarity into their preferred QE strategy, the bond market will likely send very mixed messages. The potential for chopatility is high. In the end the Fed is clearly planning some form of QE and speculative support should prevent benchmark bond yields from rising too far.  The problem is...until then dealers are in control and the pain trade will play out until a rush of new long positions are added.