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