Selling by mortgage REITs that use borrowed money contributed to declines in mortgage-backed securities, Narula said in a June 10 letter to investors that shows his fund is down 4.7 percent this year.

“We miscalculated the market's response to the possible timing of the Fed's taper,” he wrote in a June 10 letter. “The market response has been much more violent than we had anticipated.”

Narula declined to comment on the letter, which explained his losses were primarily from investments in interest-only securities. These should gain in value as borrowing costs rise and refinancing slows. Instead they slumped on concern that a confirmation by Watt, “a career politician,” would expand government efforts to help homeowners, he wrote.

Last month's performance is a stark reversal for the former Lehman Brothers Holdings Inc. mortgage trader, who founded New York-based Metacapital in 2001. He started the main fund in 2008 after closing a similar vehicle the previous year as soaring mortgage defaults created havoc in financial markets.

Eoin Treacy's view Fixed income instruments have offered some of the most reliable returns of any asset class over the last three decades; as a secular bull market propelled bonds to ever more elevated levels and yields to previously unimaginable lows.

A surge in supply is associated with the majority of major market peaks as high prices encourage issuance. On this occasion, most of the additional supply of Treasuries and mortgage bonds has been soaked up by the Fed; fuelling an impressive momentum rally. However as with any momentum move, new highs can only be sustained for as long as demand exceeds supply. At some point, everyone who wants to own the asset has already filled their quota. Where do new buyers come from then?

Ultra low interest rates, easy access to liquidity, low prepayment rates, an inability by many borrows to refinance and low absolute prices created ideal conditions for leveraged traders to participate in the mortgage bond markets and related REITs have been paying out some of the highest yields of any asset class anywhere. However, if the outlook for any of the constituent elements in this trade change the sector is likely to become more uncertain. (Also see an instructive email on the subject of mortgage REITs posted in Comment of the Day on November 19th) . The potential tapering of QE, a recovering housing sector and easing of credit conditions to facilitate refinancing all represent threats to the sector.

American Capital Agency Corp (nominal, total return) has an estimated P/E of 6.65 and despite the fact that dividends have been falling still yields 20%. However the instrument's price has lost uptrend consistency as the prospect of the Fed tapering its quantitative easing has moved centre stage. The prospects for the sector generally have become distinctly more hostile as investors begin to rein-in risk exposure.