CMO Market Update

August 12, 2019

As detailed in the Weekly Recap, several economic and geopolitical factors pushed yields down week-over-week. Really, most of the damage was done early as the 10-year Treasury closed the week at a level initially reached Monday afternoon. Even then, by Wednesday we saw another 10+ basis point decline, only to have the benchmark yield climb back above 1.70% to end the first full week of August. The effect on CMOs was widening spreads, to the tune of 5 basis points for Agency PACs and Sequentials.

August MBS Prepayment Commentary was released last Wednesday, and prepayments accelerated as expected. For investors who are trading out of shorter MBS to protect against falling rates, we have seen reinvestment in cut-coupon CMOs (e.g. 3.0 coupon off of 4.0 collateral), among other products, to lower the price and risk to underperforming yields.

In case you missed it last week, please find the July Trade Summary below.

July Trade Summary

Investors were very engaged in the CMO sector during July. Yields purchased continue to fall for fixed rate bonds, which is not surprising given the way Treasurys have declined. But on a spread basis, CMOs are still within 5-10bps of 2019 highs reached in June.

As is usually the case, fixed-rate buying dominated, although there was a slight uptick in floating rate activity after a quiet June. With rates low in general, and the potential for further declines (as of this writing, the belly of the curve is down approximately 10bps from Friday, August 2nd), it’s not surprising to see VADMs accounting for such few trades. However, if sentiment were to shift and rate expectations reverse, investors may look to that product type for more predictable cashflows if extension risk becomes a concern.

With all that said, analytics and trade characteristics have not changed drastically. Sequentials are accounting for 2/3 of trades, and durations, convexity, and average lives, although with some movement month-over-month, are in line with prior months.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks IBG, LP

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