CMO Market Update

March 15, 2021

It has been one year since the Fed cut rates to zero and spreads widened in the midst of the fear and uncertainty surrounding the pandemic. CMO spreads have been grinding tighter ever since, but have held up well to start this year despite rising Treasury yields.

In terms of activity, the trade desk continues to see good demand and flows. While recent themes are still in play, it stands to reason that the rise in Treasury yields could lead to less demand for prepayment friction bonds, such as low-loan balances and 100% NY collateral. However, rates remain at low absolute levels, and market participants are weighing if Treasury yields have already experienced the majority of their movement for the time being.

For depository institution investors, loan demand is still hurting from the pandemic and cash levels are high. This should continue to drive demand for fixed-income products broadly, and especially Agency MBS and CMOs to provide income, cashflow, and liquidity. As discussed in the monthly trade summary for February, projected yields look attractive for CMOs, particularly in the 3-5 year part of the curve where most of our customers traffic. Last month, the average projected yield on customer CMO purchases was greater than 1.00% for the first time since April 2020.

Monthly Trade Summary

Treasury yields increased meaningfully in February, specifically on the long-end of the curve with the 10-year finishing just above 1.40% last week. With spreads holding up well for Agency CMOs, projected yields on customer purchases increased again month-over-month, with the average breaching 1.00% in February. Customers extending out on the curve and slower prepayment projections (although still generally elevated) contributed to a 3.5yr average WAL for fixed-rate investments, a slight increase over January.

However, rising rates was the story of the month and floating-rate product was in high demand. 20% of trades involved floating-rate bonds, a number more in line with November and October of last year. Supply is scarce otherwise this number would have been higher.

In terms of class type, PACs have now accounted for greater than 50% of trades in 3 out of the last 4 months.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks IBG, LP

The information included herein has been obtained from sources deemed reliable, but it is not in any way guaranteed, and it, together with any opinions expressed, is subject to change at any time. Any and all details offered in this publication are preliminary and are therefore subject to change at any time. This has been prepared for general information purposes only and does not consider the specific investment objectives, financial situation and particular needs of any individual or institution. This information is, by its very nature, incomplete and specifically lacks information critical to making final investment decisions. Investors should seek financial advice as to the appropriateness of investing in any securities or investment strategies mentioned or recommended. The accuracy of the financial projections is dependent on the occurrence of future events which cannot be assured; therefore, the actual results achieved during the projection period may vary from the projections. The firm may have positions, long or short, in any or all securities mentioned. Member FINRA/SIPC.
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