After the better than expected NFP print the benchmark 10 yr TSY yield rose over 10bps to 3.88%. The selling pressure was noticeable in futures markets. Check out the spike in volume when the data published....

Activity in the MBS market had been quiet for most of the session. Lower prices were mainly a function of rising benchmark yields and adjustments to offer prices rather than straight up selling (supply/demand technicals). However as the 10 yr has failed to bounce back from 3.85....selling has started to pick up. The sellers: SERVICERS. What began with $2bn yesterday is growing as servicers shed duration from their portfolios.

Yucky chart...the FN 4.5 is -23/32. The secondary market current coupon: 4.80%....15 bps higher than yesterday....40bps higher than last Friday.



When benchmark interest rates (TSYs) rise both, the duration and expected life of "out of the money" (at par or below par) MBS coupons increase. The farther out of the money ( below 100-00) an MBS coupon is, the more it's duration and life will extend when benchmark rates rise. This is a function of the call option embedded in a mortgage backed security. This embedded call option exposes MBS investors to a great deal of extension risk. The coupons that will get hit the worst are the 4.0 and 4.5.

Plain and Simple: 4.0 and 4.5 MBS coupons are backed by loans with low mortgage rates. Interest rates are rising this morning and because the loans that make up the 4.0 and 4.5 mortgage backed securities have mortgage rates lower than current market, borrowers will have no incentive to refinance and MBS investors will be stuck in an investment that is underperforming the marketplace. 

MBS buyers dont want to be stuck in a fixed income investment that isn't keeping up with its benchmark (benchmark yields higher than MBS coupon yield)...if interest rates move higher this implies those MBS holders could be reinvesting their money in a higher yielding debt instrument...they could be earning more return/MORE CASH FLOWS!!!!  




2s vs. 5s: 152bps

2s vs. 10s: 254bps

5s vs. 10s: 102bps