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Following a period of continued falling interest rates, mortgage-backed securities continue to retrace their steps. As foreign financial markets continue to stabilize and the US economy recovers, the flight to quality buying of MBS's seen earlier in the year has diminished.

Market participants are constantly searching for investment opportunities that will provide the greatest return with the least amount of acceptable risk. Investment products inherently all possess some sort of risk. For example, one risk associated with mortgage-backed securities is a fear of pre-payment. A homeowner obtains a loan for a certain duration of time at a certain interest rate. As interest rates fall, homeowners tend to refinance their homes, which leads to the early payoff of the first loan and the origination of a new loan at a lower interest rate. Investors are cognizant of this scenario and factor this risk into their demand for mortgage-backed securities. If the demand for MBS's is strong, the price of the MBS's increase, and interest rates head lower. However, if the demand for MBS's weakens, interest rates rise.

Past demand for MBS's had been a result of financial turmoil in foreign economies and a fear that the US stock market would remain weak. As foreign financial markets began to erode, market participants withdrew their funds and searched for a safe haven in the US financial markets. With the backing of the US Government, investors viewed the US Treasury and MBS markets as less risky investment opportunities amid global economic uncertainty. With this influx of funds into MBS's, interest rates were driven lower.

Mortgage-backed securities are currently struggling with a reduction in the flight to quality bid as a result of stabilization that is occurring in other financial markets and potential inflation fears. Continued gains in the US stock market add to the competition for investors' funds.