Besides profit taking and intraday stock market volatility, which we view as the main culprits, here is another reason why bonds are selling today: (Reuters) - Moody's Investors Service said on Thursday there is a very small but rising risk of a short-lived default by the United States if there is no increase in its statutory debt limit in coming weeks. In a statement, Moody's said if there is no progress in increasing the debt limit, it would expect to place the Aaa sovereign credit rating on review for a possible downgrade. "If the debt limit is raised and default avoided, the Aaa rating will be maintained. However, the rating outlook will depend on the outcome of negotiations on deficit reduction," Moody's said.

(Reuters) - Bankers and housing advocates have joined together in a strange-bedfellows alliance to push back against a proposal from U.S. regulators the groups argue will make it more difficult for Americans to afford a home. The proposal, required by the 2010 Dodd-Frank financial reform law, calls for lenders to keep a portion of all but the safest mortgages on their books, rather than passing them off to the secondary market. A wide array of industry and consumer groups and politicians say regulators have gone too far in defining the safest mortgages, particularly a 20 percent down payment requirement. "What is proposed here by the regulatory agencies will most definitely throw a wet rag on housing recovery in this country," John Taylor, chief executive of the National Community Reinvestment Coalition, said at a news conference on Thursday. Mortgages that meet strict underwriting standards are exempt from the risk-retention requirement. These exempt loans are known as Qualified Residential Mortgages (QRM). On Wednesday the housing and lending groups took particular aim at that requirement, arguing that coming up with such a down payment will be difficult for most borrowers. The regulators' proposal comes in response to widespread criticism that lending standards became too lax in the run-up to the financial crisis because loans were bundled together and sold as securities. Critics argue that the originator of the loan or the firm creating the security had little stake in whether the loan performed because it was being sold to investors. READ MORE: http://www.mortgagenewsdaily.com/05312011_housing_reform_qrm.asp

So much for "settling into a range"....Stocks are staging a corrective comeback which has pushed benchmark TSYs through key support at 3.00% and led production MBS coupon prices to new intraday lows . Reprices for the worse are possible at these levels, especially on note rates below 4.75%. This sort of behavior is to be expected ahead of a high-risk event (Employment Situation Report tomorrow morning) as investors look to secure a portion of their earnings "just in case" data surprises to the upside. This should serve as a reminder of the risks associated with floating loans that must be locked on a short timeline. Even in a broader bullish trend, back-ups and reversals are always a threat.

After a choppy morning filled with profit taking and position squaring, trading activity is beginning to taper off into the lunch hours. Sudden ntraday stock declines have aided our cause as a "risk off" sentiment is preventing rates from extending early session weakness. Production MBS coupons actually attempted a recovery rally late this morning when the floor fell from underneath equities, but once again profit taking and pre-auction (next week) curve steepeners have put a stop to that move. In the heat of the moment, one hair-trigger lender actually recalled and repriced for the better (FAMC), but they were alone in that action. Both benchmark TSYs and MBS seem to be settling into a range now, below yesterday's best levels but above key technical support. While the market appears to be lulling itself to sleep, the day is only half-way done and volatility is always on the table ahead of a high-risk event: The Employment Situation Report tomorrow morning. Stay tuned for further developments.

Next week's Treasury auctions will include $32 bln in 3 year notes on Tuesday, $21 bln of reopened 10yr notes, and $13 bln of reopened 30yr bonds. While the $32 bln in 3's is unchanged from the last 3yr auction, 10's and 30's are reduced by $3 bln versus their previous offerings. This is not part of a trend or even that uncommon for 10's and 30's, as each have seen these amounts in the recent past. But 3 yr notes have not dipped below $32 bln in over a year, so that's where markets will continue to watch for a shift in supply that they actually read something into.