CMO Market Update

February 14, 2022

The yield curve rose again last week and once more it was the front-end leading the way. The 1-year increased 15 basis points, and the 2- and 3-year rose 19 basis points each. We have already seen some spread tightening in the CMO space to start February and more could occur. However, nominal yields continue to look attractive. As discussed in the monthly trade summary, the average projected yield on customer purchases has been increasing steadily to end 2021 and start 2022. Now at the halfway point of the month, it’s reasonable to expect February purchases will average around a 2.00% yield. This makes sense, however, given the sell off and the fact that investors have migrated to higher coupons.

Last week, there was good demand across the stack. Coupons in the 2.00% – 3.00% range saw the most activity. Even premium-averse investors have been able to participate with current levels ranging from 99 to 101 handles for 2.00% -2.50% PACs and Sequentials. Opening up this morning, Treasury yields are rising again. Below are the Treasury and CMO sections from last week’s Investment Alternatives Matrix.

In case you missed it last week, the monthly trade summary for January is below.

Monthly Trade Summary

December and January analytics on CMO trades look very similar with one big exception: projected yields were 20 basis points higher in January. This follows what we saw throughout the month including rising Treasury yields and resilient nominal spreads. To be clear, we have seen spreads tighten in the early part of February, so it remains to be seen how resilient spreads will be in February.

Effective Duration, WAL, and Convexity have been steady for the last few months. In the height of the uncertainty surrounding the pandemic, investors on average shortened up new purchases to a 3-year WAL. Now, as Treasury and CMO yields have increased, customers have extended to nearly a 4.5 year WAL. As shown in the summary table below, it has been a steady, methodical increase out the curve and not necessarily a risk-on reaction to the higher yields we have seen in 2022. This is something to monitor in the months ahead and in context with any further increases in rates.

While fixed-rate coupons usually dominate activity, January was an extreme example. And for the second month in a row, Sequentials accounted for the most par traded by structure. This comes after PACs were the predominant structure of choice for most of 2021.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks