CMO Market Update

February 7, 2022

Last week was a continuation of the early themes of 2022 in the CMO sector: rising yields, tightening spreads, and active investors. Our customers typically traffic in the 3-5 year part of the curve in this space. This portion of the yield curve has risen 50+ basis points year-to-date. As a result, we have observed some spread tightening on short to intermediate term PACs and Sequentials. This has not deterred investors as nominal yields are at their highs since the pandemic.

Activity started slow last week, but investors were very active Thursday and Friday. One structure in high demand was a 2.5% coupon off reperforming 30-year 2.5% collateral. Additionally, strong demand remains for 2.0% coupons off 2.5% – 3.5% traditional and prepay friction collateral.

Below is the monthly trade summary for January.

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

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