Short question, long answer.

First of all, keep in mind that there's no perfect way to observe that MBS are outperforming or underperforming Treasury benchmarks simply by looking at the changes in MBS prices vs Treasury prices/yields day over day. There are 2-3 excel sheets with 370 rows and 40 columns of math that go into arriving at bond-equivalent yields for MBS. Even then, those valuations are subjective, though the consensus tends to come close to reality. It's still an imperfect science. But the point is we can't usually be sure about the level of relative performance without crunching those numbers

Beyond that, and specifically to the question of underperformance, MBS almost always make fewer gains than Treasuries into heady rallies ESPECIALLY "Flight-to-Safety" rallies like the ones that bring 10yr notes up a point in price on some headline-driven drama. Think about "risk-on/risk-off" and the nature of Treasuries vs MBS. UST's are "risk-free" whereas MBS are a "spread product" that have a risk component that results in their higher-than-risk-free yields. As such, MBS suffer relative to TSY's when RISK OFF is the order of the day.

Throw liquidity and/or settlement-related flow issues into the mix and MBS are all but killed. Bottom lines:

1. MBS aren't quite as weak as they appear, look at the price change in 5 year yields for instance. Modified duration of a 3.5 MBS is only 5.5 years. 10yr isn't the best benchmark for valuation right now!

2. volume's a bit light for MBS and we've tightened over the past two days.

3. It's a settlement day today. accounts are more concerned with squaring up their positions for the roll than keeping pace with what could prove to be a short-lived flight-to-safety spike. MBS can't chase this FTS Dragon today folks. Don't let it bother you.

This morning's bond market rally and stock sell-off is almost exclusively about Italy. Perhaps a small amount of flight-to-safety bid is attributable to some lingering uncertainty as to who will take the reigns in Greece but the big news moving markets overnight centers on the Buono del Tesoro Poliennales, or BTPs which are Italy's government bonds.

Another enigmatic acronym, the LCH (London Clearing House - effectively the intermediary for a ton of various counterparty trading in Europe) raised margin requirements on Italian debt. Spreads between BTPs and German Bunds (EU's version of US TSYs) were destroyed to the tune of almost 80bps overnight and the entirety of the financial world is once again humming similar tunes to those heard before Greece really started to hit the skids. It's an eerily similar situation really, and one that is partly already priced into current strength in TSYs (we say again and again that DOMESTIC economic turmoil is enough to get 10yr yields to 2.3% give or take, but the EU turmoil is what takes us lower. Just a hypothesis on our end, but there's some compelling evidence).

At any rate, levels in US bond markets are rather sharply improved this morning despite the looming 10yr note auction:

Fannie 3.5's are up 3/8ths at 102-05
10yr yields are 11 bps lower at 1.97
S&P Futures are down a not-insignificant 30 pts
and the Euro fell to its lowest levels in a month, erasing all of November's gains in one night.

This should have a salubrious effect on rate sheets this morning, but do expect some level of inconsistency as different lenders may have different considerations during this month's MBS settlement process, taking place from yesterday through tomorrow. Ideally, we'd like to see 102-02 hold up as support (leaving 101-26 intact after the roll), but the day is young, and as one blind man said to the other, we'll see what we'll see.

Fannie Mae reported a third-quarter net loss of $5.1 billion and announced that is asking the government for $7.8 billion in aid to cover its losses.

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