CMO Market Update
August 26, 2019
Last week saw mixed movement in Treasury yields and little change in CMO spreads. Yields rose for Treasurys maturing in 3 months to 3 years, while yields for intermediate to longer notes and bonds declined 1-2 basis points. Spreads for 3- and 5-year PACs widened 2 basis points, and 3-year Sequentials widened 3 basis points.
With the preciptious drop in Treasury yields this year, CMOs continue to look attractive on a relative value basis. CMO spreads to Treasurys have widened steadily in 2019. For context, consider the following. For those active in the CMO space, our customers typically invest in bonds with a 3-5 year average life, although that number has been trending closer to 3-years in 2019. The last time investors could earn comprapable spread on 3-year bonds was July of 2016. Current spread levels on 5-year PACs and Sequentials were last seen in January of 2014. Spread buyers should be intrigued by these multi-year highs.
Another byproduct of falling rates is unexpected cashflow returning to investors’ portfolios. Issuers have called a significant number of bonds recently leaving portfolio managers with unexpteced liquidity. When thinking about reinvestment, buyers may want to consider call-protected cashflows as there is no guarantee that rates will remain at current levels, and could indeed fall further. When it comes to CMOs, cut-coupons (e.g. 3.0 coupon off of 4.0 collateral) can help lower the price and risk to underperforming yields.
In next week’s CMO update, we will review August activity with the Monthly Trade Summary.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP