CMO Market Update

August 9, 2021

Customers were very active in the CMO sector last week, including a pickup in two-way flow with some portfolio managers cleaning up odd-lot positions.  This is a welcomed development, both in terms overall activity as well as secondary supply if this were to continue.  The most popular structure by far last week was a 1.00% coupon off 2.50% jumbo collateral. Additionally, 1.75% and 2.00% coupon bonds, also off jumbo collateral, were in demand.

Readers will find below a snapshot of the Treasury and CMO sections from last week’s Investment Alternatives Matrix. At least as it pertains to Treasurys, this serves more as a comparison tool than a depiction of where rates stand. Yields for maturities 5-years and longer ended the week 10-13 basis points higher from Tuesday’s close. As of this writing, Treasurys have sold off a little more pushing rates even higher with the 10-year yield at 1.31%. It just goes to show how conditions can change, and how quickly one might have to act to seize an opportunity, whether it be a chance to sell at a more favorable price or purchase an attractive yield.

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In case you missed it last week, the July trade summary is below.

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

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