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US mortgages sell off and new buyers come in

Explanations for the market's significant retreat in November are more complex than for previous years.

Selling in the market last month made US mortgage bonds the cheapest they have been for three years. During previous sell-offs, commentators have blamed the convexity trade, but this time the reasons for the pressure on the market look more complex.

The convexity trade played a major part in the mortgage sell-offs in 2001 and 2003, as investors repositioned their portfolios. The trade occurs because, when the market sells

off, the duration of the loan pool increases, forcing mortgage investors to sell their unwanted duration, which can result in the bonds selling off even more. This played some part in the November sell-off but, as the mortgage market is very long in duration already, analysts and traders think other major pressures are involved.

Traders think many traditional buyers in the mortgage market are staying away. “The GSEs, which have been massive buyers in the past, are not being so aggressive, and non-US investors are taking pause,” says Kevin White, managing director and global head of securitized product syndicate at Lehman Brothers.

Fannie Mae, for example, has been selling all this year to meet its new capital guidelines. And with the curve so flat, banks are not buying either.

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