CMO Market Update
August 16, 2021
Activity was very strong in the CMO sector last week. Throughout this year, the lowest cuts have been the most popular, primarily 1.00% – 1.25% coupon bonds. While those were certainly still in demand last week, investors were just as engaged in the higher end of the 1.00% – 2.00% range, working their way up the coupon stack to 1.50% and 1.75% cuts. Regardless of coupon, jumbo 2.50% collateral was the most common from last week’s trades, with some higher coupon (3.00% and 4.00%), traditional collateral mixed in as well.
Customers continue to favor PACs when it comes to structure. This is broken down for recent months in the July trade summary (included below). There you will see that PACs have accounted for more trades than Sequentials in 4 out of the last 5 months.
Spreads were unchanged last week and remain fairly resilient in this sector. For bonds with a 4-year average life, the portion of the curve in which are customers are most active right now, a 1.00% projected yield has remained attainable, and with little to no premium risk attached.
Below are the Treasury and CMO sections from last week’s Investment Alternatives Matrix. Please keep in mind that since this was released last Tuesday, the 3-, 5-, and 10-year treasury yields are down 4, 8, and 10 basis points, respectively.
July Trade Summary
In last week’s update, I expressed an expectation that the July trade summary would reveal a somewhat conservative approach from portfolio managers as it relates to extending out on the curve with new CMO purchases. That forecast was incorrect. The summary statistics show that investors did extend, albeit slightly, month over month compared to investments made in June.
July saw CMO investors purchased fixed-rate bonds with an average WAL of 4.3 years. This is the longest WAL we have seen since 4.9 years in March. Projected yields on July purchases even surpassed what was observed in March. While this may be surpising, it shows that investors still have some appetite for risk, whether it be exposure to prepayments in the short term or extension in the future, in the face of this low rate environment.
In terms of coupon type, fixed-rate investments dominated activity with floating-rate trades accounting for less than 1.00% of trades by current par. This is a stark contrast compared to May and June, months in which floating-rate activity was about 15.00% of trades. However, the lack of floating-rate activity in July is not too surprising given how rates fell during the month.
Looking at trades broken down by class type, PACs reclaimed the majority of activity after Sequentials were the more popular structure in June. As shown in the table below, customers have favored PACs for most of 2021. One development in July is that a handful of decent sized blocks traded involving TAC structures. These are accounted for in the “Other” category. At this point, it’s too early to say if this is a blip on the radar or a sign of things to come. As always, time will tell.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP