CMO Market Update

January 25, 2021

CMO spreads to Treasury yields were unchanged last week. Despite some slight tightening two weeks ago, CMO spreads have held up well compared to the rise in Treasury yields during the first week of the year. Depending on structure and maturity, Investors shouldn’t have to reach too far in terms of duration and premium risk to find a bond with a projected yield of 0.80% – 0.90%. Reaching 1.00% however, will entail adding incremental risk.

For premium averse investors, extending out on the curve with lower coupons is one option, and the third to last bond below from our weekly Investment Alternatives Matrix below would be an example of that [Agcy SEQ (4.2 / 5.5 / 8.0) 1.50% coupon]. On the other hand, investors that are willing to pay up should be able to find a 1.00% yield and with nearly half the base case projected WAL (see Agcy PAC below outlined in red). Of course, it’s not just as easy as paying up to get a higher yield. In this scenario, prepayment risk is the source of increased yield, and if speeds are faster than projected then the realized yield will be less than expected due to faster premium writedowns.

In terms of trades, stripped down PACs and Sequentials continue to see good activity in the fixed-rate space. When supply is available, SOFR floaters see high demand and that was the case last week.  Recent deals have featured coupons of SOFR + 25 basis points.

Recall from the December trade summary that customer activity in floating-rate bonds was strong in the middle of 2020, but tailed off in the last two months of the year. The January trade summary will be the focus of next week’s update, so it will be interesting to see how this trend is playing out.

Later this week, pricing will be udpated on our Client Access portal as of January 21. For those with access, this will give you a chance to review updated analytics and gain/loss estimates. If you do not have access and would like to register, please click here.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks IBG, LP

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