Good Morning.

Recap of Yesterday...

Construction Spending fell 0.6% in November to a total of $900.1 billion. That was the lowest print since July 2003 and the seventh straight month of contraction in construction spending. Spending on private home construction declined 1.6% after seeing a 4.8% expansion in October.

ISM manufacturing index jumped to a 44-month high of 55.9. All five major components moved upwards including a 5.2-point jump in the new orders index to 65.5 ― the highest reading since May 2004. Investors looking for the December employment report to show the first positive gain in two years were also encouraged by the 52.0 reading in the employment component.

Around the world, manufacturing is picking up. The question remains: Is the recent expansion in the manufacturing sector a function of over contraction and seasonal demand (influenced by stimulus and stock markets) or are consumers really starting to spend more. I am more willing to accept the first explanation...the latter seems unsustainable.

This chart is from Reuters highlighting manufacturing sectors around the world:

INFLATION WATCH: note the prices paid index within the ISM data jumped to 61.5 from 55 in November. We discussed the 'Prices Paid' in the context of inflationary anxieties last week when the Chicago PMI report was released. TAKE A READ

Fed Governor Elizabeth Duke gave the markets more of the same low rates for an "extended period" rhetoric yesterday...blaming substantial resource slack and tight credit conditions. She made a specific point to call attention to headwinds in housing due to high numbers of foreclosures and TIGHT CREDIT CONDITIONS. READ MORE

PIMCO is reducing US and UK bond market exposure. This goes along with our Q1 interest rate outlook. READ MORE

After an early morning hiccup following the better than expected read on the manufacturing sector, the 10yr TSY note yield moved progressively lower throughout the session. Although rates prices/yields remained within the confines of the recent range, the Treasury market traded well yesterday even as stocks continued to march higher and higher.

Mortgages traded well in below average volume. Loan origination supply continues to be produced at a slow pace. Blame tight credit conditions and a weak economic environment (labor markets) for the continually SLOW loan origination. Light supply combined with official buying (the Fed) have kept MBS valuations extremely RICH throughout the course of the Fed's MBS purchase program. This has served to attract buyers into the MBS market which has in turn kept yield spreads tight (rich) vs. benchmarks.

Plain and Simple: light loan supply and Fed support have kept MBS yields close to Treasury yields.

The FN 4.5 went out +0-09 at 100-03 yielding 4.476% yesterday. The secondary market current coupon was 4.465%. Yield spreads closed TIGHTER on the day. I did see a few reprices for the better but nothing broad based, for the most part rate sheet rebate was the same as last week or worse yesterday.

So Far Today...

The SHANGHAI closed +1.18%, the HANG SENG ended the session +2.09%, the TOPIX +0.42%, NIKKEI +0.25%. The DAX is -0.27%, the CAC is +0.08%, and the FTSE is +0.37%.

In the US, the S&P is flat, -0.1% at 1131.88, the Dow is -0.32% at 10550 and the NASDAQ is -0.26% at 2302.

The 3.375 coupon bearing 10yr TSY note is +0-09 at 96-20 yielding 3.786%. 3.78% is a key resistance level, a break below would be a sign of corrective progress, unfortunately we have to view these moves outside the range as short term until labor market data confirms or denies directionality on Friday.

Mortgages are once again benefiting from slow trading flows (lack of supply/sellers) and positive progress in benchmarks. The FN 4.5 is +0-10 at 100-13 yielding 4.466%.

We have 10am data on deck. Pending Home Sales(-2.00% vs. prior +3.7%)  and Factory Orders (+0.5% vs. +0.6% prior). This data will move markets. Will update in comments when released.