Bonds shook off a hot inflation reading Thursday and rallied. UMBS 6.0 closed at 98.32, up 29 cents, the 10-year Treasury fell to 5.241%, and the average 30-year fixed eased to 7.54% from 7.60%.

The day went both ways. At 10 AM ET the ISM manufacturing prices-paid index came in at 77.9 against a 72.3 forecast. Mortgage bonds dropped to 97.80 and the 10-year touched 5.34%. That level held, and by 10:46 AM MBS were back to unchanged. The rally kept building into the afternoon, peaking at 98.45 (up 42 cents) around 1:30 PM, and gave a little back into the close. From low to high that's about a 65-cent range, the widest of the week. Short-term Treasuries led: the 2-year fell 11 basis points and the 10-year less than 5, so expectations for Fed policy moved, not just long-term rates. No single catalyst explains it. Traders covering bets on higher rates ahead of Friday, worries in European bond markets, reassuring comments from Fed officials, and buying at the 5.34% level all likely played a part.

For borrowers, the 6-basis-point drop in the average rate is the first real relief after six straight weeks of increases. One day is not a turn, though. Weekly jobless claims stayed low at 197,000, continuing claims fell to 1.70 million, and the labor market still looks firm. The Fed debate is still hold versus hike. Friday's September jobs report at 8:30 AM ET is the test. A strong number could erase today's gains in a single session, and a soft one would be the first sign this rally can run.

— David Burson, NetRate Mortgage