MBS are doing great this morning, with the 5.5% now at 100-25!  But there is a caveat.

The spreads between treasuries and MBS are starting to get a bit "gappy' with respect to recent weeks.  With the dearth of Mortgage-related headline shockers, investors and traders have waded farther and farther into "the deep end" of risk aversion where the practically amphibious treasuries dwell.  Granted this gap has been even tighter in the past before the world realized that there is an element of risk in ABS, but it has not been this tight since that excrement became fan-bound.  In fact, some consider that it might be "pushing it" a bit when it comes to improvement in recent weeks relative to what it "deserves."

As operators in the mortgage industry, you know and I know that the increased rigor of underwriting guidelines will certainly have a drastically positive effect on defaults, but according to one of our friends who is one of the leading senior analysts for the MBS market (he wishes to remain anonymous due to his golf handicap), "MBS have tightened up a little too quick in recent weeks.  We have some profit taking this morning as well as some retraction from run up to the tights."

What he means by "run up to the tights" is simply that MBS have tightened the gap to treasuries quickly.  Profit taking, of course, indicates that investors holding MBS see attractive potential returns when prices reach these levels.  Indeed, we've seen frequent technical resistance to the 101-00 ceiling area in the last few months. 

As our analyst friend's call of the MBS market is usually better than his golf game, it's something to keep in mind.  So, as I mentioned this morning that treasuries were not tracking well with MBS, this would be the reason.  As you see treasuries improve substantially, don't count on a similarly substantial MBS improvement (even though they will USUALLY be moving in the same direction).

Keep in mind that this does not speak to the DIRECTION of MBS (for that we focus on macro-factors, technicals, reports, and headlines), but it does mean that the guy down the road shopping for a 10-20 I/O should be happy to get under 6% as it probably won't shed another .75% nearly as fast as it shed the last .75%.  Diminishing returns, eh?