Bank of America Merrill Lynch continues to recommend investors remain underweight in agency mortgage-backed securities because of further prepayment risk associated with the Fed's reinvesting MBS proceeds into Treasuries. Analysts also maintain an overweight position in non-agency MBS due to good yields and the long-term outlook of shrinking supply. The Federal Reserve lowered its MBS portfolio by about $24 billion in August. And while officials want to reinvest maturing MBS in Treasuries to maintain an accommodative monetary policy, "the Fed confused matters somewhat by stating that it also could still reinvest in MBS," the analysts said. "Faster than expected prepayments cause mortgages to underperform and rolls to decline," Chris Flanagan, MBS/ABS strategist at Bank of American Securities, said.  "Despite the recent bear steepening we continue to believe that we are at the cusp of classic rate induced refinancing wave and 2008/2009 4.5s and 5s are at most risk." Analysts said demand for investment-grade non-agency paper remains strong, and bid-list volume for non-agency MBS rose last week to $1.5 billion from "an anemic" $300 million the week prior. Bid-list volume for subprime MBS inverted non-agencies as activity fell to $300 million last week after $1.6 billion the week before the Labor Day holiday. BofAML analysts also said supply coming from CDO liquidations has tapered off with just one liquidation expected in the next two weeks. Write to Jason Philyaw.