CMO Market Update

December 13, 2021

Nominal CMO spreads tightened about 2 bps last week. This was largely due to rising Treasury yields, which increased across the curve, most significantly for maturities three years and longer. The 3-year Treasury increased 14 bps in yield week-over-week, while the 5-year rose 12 bps. We make note of these maturities because it is the part of the curve in which our customers typically traffic in this sector.

As we approach the end of the year, one developing trend we’ll be watching into 2022 is investors moving up the coupon stack in the CMO space and generally taking more risk-seeking behavior. For the better part of the last two years, most inquiries have been for 1.00% – 1.50% coupon cuts. Now, traders are seeing more traction in the 1.50% – 2.00% range. Additionally, last week’s activity showed less preference for structure and a willingness to take on greater price volatility. To that end, we included a handful of 2.00% examples in last week’s Investment Alternatives Matrix. The Treasury and CMO sections are shown below for reference.

Late next week, we will get our first look at December pricing. For those that work with the portfolio, this will give you an opportunity to review updated analytics and gain/loss estimates before year-end. If you are not signed up for our Client Access portal, please click here to register.

Monthly Trade Summary

Treasury yields were volatile in November and finished the month mixed. Yields on 1-3 year government bonds increased 10, 7, and 8 basis points, respectively. Bonds 5-years and longer decreased in yield, with the 10-year Treasury dropping 11 basis points.

Investors were active in the CMO space during November, except for the holiday-shortened week of Thanksgiving. Overall, Yield Book analytics on November purchases were in line with the prior two months with respect to yield, effective duration, and Weighted Average Life (WAL). The average projected yield purchased declined to 1.35%, but November investments were slightly shorter with a WAL of 3.7, as compared to 4.1 in October.

As shown in the table below, floating-rate activity increased meaningfully as based on current par traded. However, it would not be fair to say there was widespread demand for floating-rate coupons as a small number of trades accounted for the jump month-over-month. We’ve observed this a few times in 2021, previously in August.

The majority of inquiries in this sector continue to be for low coupon PACs and Sequentials. Breaking activity down by structure, PACs accounted for more than 50% of trades again last month, although Sequentials were as close to 50% as they have been in the last 5 months. June is the only month this year in which customers have purchased more Sequentials than PACs.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks