CMO Market Update

December 14, 2020

CMO spreads to Treasury yields were unchanged last week. For the structures we monitor, spreads have tightened approximately 8bps in the fourth quarter. Most of that movement occurred in October, and spreads  have now tightened on a year-to-date basis.

Activity in the CMO space continues to be defined by familiar themes with investors buying bonds outright from cash and focusing on low coupon cuts off traditional and jumbo collateral. One new development, however, which has played out in the CMO space as well as other sectors, is investors considering and purchasing bonds outside of their normal product scope. As it relates to agency CMOs, our trade desk has observed customers buying more PACs than Sequentials in recent months. As mentioned in the November monthly trade summary below, last month was the first time since April that customers bought more PACs than Sequentials.

For context on market yields and pricing, below is the CMO section from last week’s Investment Alternatives Matrix.

Monthly Trade Summary

Rates have risen from where they were in the summer and the 10-year Treasury yields 94bps as of this writing. The average yield purchased on a fixed-rate CMO has reflected this pop in rates over the last couple of months. While the average yield purchased in November decreased from October, investors were also buying shorter bonds with a projected base case WAL of 2.4 years, compared to 3.4 years in October.

While some portfolio managers have been willing to extend out on the curve, on average, investors are sticking to bonds with a base case WAL of 2-3 years. This is a sweetspot for many depository customers looking for predictable cashflow and yield pickup.

Activity in floating-rate bonds was meaningful again, but fixed-rate coupons were the predominant trade. As mentioned in recent CMO updates, low coupon cuts (1.00% – 1.50%) are in high demand as premium averse investors seek lower dollar prices.

One of the biggest changes month-over-month is that PACs outpaced Sequentials in terms of Par Amount traded by class type. The last time this happened was in April.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks IBG, LP

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