CMO Market Update

April 12, 2021

Spread tightening was a theme for most sectors last week and the CMO space was no exception. CMO spreads to Treasury yields tightened 2 basis points week-over-week. On a year-to-date basis, CMO spreads are wider by a couple basis points.

In terms of activity, the trade desk continues to see one-way flows with investors purchasing bonds outright from cash. Although rates increased meaningfully in the first quarter, they are still at low absolute levels. As a result, investors have healthy amounts of cash on hand due to prepayments and called bonds. Furthermore, depositories are still grappling with reduced loan demand because of the economic environment, and funds are finding a home in bonds.

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In case you missed it last week, the March Trade Summary is below. First quarter themes continue to play out in April as CMO investors are extending out to around a 5-year average life, primarily with cut-coupons while trying limit premium and extension risks.

March Trade Summary

March was a very active month in the CMO space as depository institutions have ample amounts of cash on hand and rising yields brought buyers into the market. Rising rates were reflected in the average projected yield purchased by customers last month, jumping from 1.10% in February to 1.21% in March. As discussed in recent CMO updates, investors have been extending out on the curve for additional spread pickup, and that was the case again this month. The average WAL purchased for a fixed-rate agency CMO was nearly 5 years, a notable increase over last month. But this aligns with weekly activity observed and feedback received from customers. We have highlighted previously this area of the curve when referencing the weekly Investment Alternatives Matrix (See CMO section below), as customers continue to favor cut coupons (1.00% – 1.50%) and avoid premiums over 102-103.

Another point of interest from the analytics: floating-rate purchases were down month-over-month. Although last month was a high watermark for floating-rate purchases, this was perhaps a steeper drop off than expected. This could be more of a supply issue than anything else.

And lastly, there was some VADM activity for the first time in a couple months. While marginal, perhaps managing extension risk is on investors’ minds with the 10-year Treasury holding it’s current level of 1.70%. For the rest of the metrics, please see the table below.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks IBG, LP

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