CHICAGO, Jan 5 (IFR) - As the domestic session opened, 10-year notes were up 13+/32nds on weaker stocks overnight; however, the ADP Employment (Dec) report stunned the market with 297k jobs created versus an expectation of +100k.

Treasuries immediately plunged with 10s dropping as much as 27 ticks in the aftermath before finding a temporary floor at 3.428%.

ISM non-Manufacturing Index (Dec) also was better than expected - increasing to 57.1 from 55.0 and versus a more modest projected increase to 55.6. This sent Treasuries down steadily through the remainder of the session. At 3:00, the 10-year note was marked down 34/32nds to 92-28+ (3.483%) with the 2s10s slope 3.4 basis points steeper to +275.3.

Lower coupon MBS spreads widened on the sell-off as profit taking showed up, along with other investors shedding duration (convexity-related) to move up in coupon.

Banks, though, took advantage of the lower prices to add lower coupons. The sell-off, however, did not elicit the response seen in the last few weeks of 2010 when the back up in rates precipitated heavy convexity-related selling from servicers.

At this time, there is limited additional extension risk inherent in the market, said FTN Financial analysts, and there is virtually no hedging/convexity risk from a further sell-off. At this time, call risk is the bigger risk. Overall, MBS volume was modestly above normal today, according to TradeWeb's experience, with better selling.

The specified market was active today with banks, insurance companies and REITS taking advantage of attractive pay-ups with some looking as well for call protection. Originator bid lists, in particular, have picked up as pool notification approaches next week. The good real money demand, however, has kept pay-ups firm.

MBS price decline ranged from - 29 to -3+ ticks on FN 3.5s through 6.5s; Dwarfs lost 19 to 8+ ticks on 3.5s through 6s. Spreads were flat versus swaps on 4s through 5.5s, and slightly tighter in the wings. Versus 10-year notes, spreads were 1/8 point wider on 5s and lower, while 6s and 6.5s were tighter. GN/FNs were higher, except 4.5s.


Thursday's data has more jobs related news at 8:30 with the weekly Initial and Continuing Claims reports for the weeks ending 1/1 and 12/25, respectively. Initial Claims is projected higher to 400k from 388k, while Continuing Claims is seen lower to 4.1mln from 4.13mln. Other events include Freddie Mac's weekly report on mortgage rates at 10:00 and Treasury's announcement of 3s, 10s and 30s at 11:00 - estimated at $66bln.

In mortgages, Agency MBS prepayment reports are released beginning late afternoon. 30-year conventional prepayment speeds in IFR's sample are projected to increase around 2% in December from November with the percentage gains relatively uniform across the coupon stack.

Meanwhile, Ginnies are seen slowing around 3% on average with the largest percentage declines in 5.5s through 6.5s. Paydowns are estimated at $137 billion with net issuance expected to be modestly positive. For December, agency issuance totaled $144 billion.

MBS analysts at BNP Paribas warn that speeds could be faster than expected as year-end capital issues may have led to faster processing and securitization by banks in order to improve capital ratios. They point to higher gross issuance in December for Fannie and Freddie Mac - $117bln versus $101bln in November, according to eMBS.

If this occurred and applications were processed faster resulting in faster speeds, it would take issuance and prepays out of future months, analysts added.

Three events converge late week to provide a supportive tone for MBS: paydowns, non-farm payrolls in which vol typically declines following the news and Class A pre-net out with 48-hour day looming next Tuesday. Speaking of non-farm payrolls, upward revisions are occurring following today's ADP report. For example, Deutsche Bank economists raised their projection to +150k from +100k.

Prior to ADP, consensus predicted +140k and is now at +175k, according to IFR Markets.

(Sallyann Runyan is a senior IFR analyst)