CMO Market Update
January 11, 2021
CMO spreads to Treasury yields were unchanged in the first week of 2021. For most CMO structures and maturities that we monitor, spreads are at their tightest levels since mid-2019. However, yields for bonds 5-years and longer look relatively attractive as they were last seen at these levels in the summer of 2020. Soon after July, spreads began tightening and continued to do so to finish last year.
These measures provide context for observations of recent customer trends. As discussed in the December trade summary below, investors have been trafficking in products outside of their normal bread and butter investments. With CMOs, extending out on the curve has been noticable.
Also driving activity, low-coupon cuts (0.5% – 1.5%) off different collateral types are helping investors shield the portfolio from premium risk while also generating cash flow. 0.5% – 1.5% coupon bonds have been trading from slight discounts to 102 handles, which premium averse investors should find reasonable.
Monthly Trade Summary
Analytics on December CMO trades support what has been a noticable trend to close out the year: investors are willing to try something different. In relation to CMOs, customers are extending out on the curve. Typically, the average WAL purchased by customers is 2.5 years. In 2 of the last 3 months, the average WAL purchased as been closer to 3 years. Consequently, the average yield and effective duration purchased has increased to 0.79% and 3.6, respectively.
Low cut-coupons (1.0% – 1.5%, traditional and jumbo collateral) were the primary driver of activity in December. Investors continue to show an aversion to premiums and bonds with coupons in the 1.0% – 1.5% part of the stack have been trading in a range of par to 102 handles (see CMO section of Investment Alternatives Matrix). Activity in floating-rate bonds declined again in December, accounting for just 7% of CMO trades. This follows a string of strong tallies in the summer and fall months when floating-rate bonds were > 20% of CMO trades.
Breaking down trades by class-type, PACs outpaced Sequentials for the second consecutive month. PACs have accounted for more than 60% of trades in November and December.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP