CMO Market Update
June 15, 2020
Activity continues to center on lower coupons in the fixed-rate space as investors seek protection from prepayments. There has been decent activity in HECM floaters as well. Trades last week were defined by one-way flow with customers investing outright from cash. As mentioned in recent weeks, the Trade Desk is actively seeking bid lists for customers looking to clean up smaller positions or potentially take some profits as dollar prices remain elevated.
CMO spreads to Treasury yields tightened 4 basis points last week. Tightening has been the trend since March when spreads reached their high watermark. However, spreads in this space are still wider for the year by 10-20 basis points depending on maturity and structure.
May Trade Summary
The average projected yield on customer purchases of fixed-rate CMOs has bounced around in recent months, but seems to have settled around 1.00%. When comparing to January data (see table below), one can see how much has changed since the start of the year. Customers investing in bonds with a 2-3 year average life came into 2020 purchasing projected yields around 2% on average. That has been cut in half.
One noticeable trend in recent months has been the increased activity in floating-rate CMOs. Some larger block trades accounted for this, perhaps driven by specific balance sheet needs or individual rate outlooks. Although this is not representative of widespread participation by investors, it is clearly having an effect on the metrics and something worth monitoring going forward. While spread levels for this coupon type are lower than that of similar-maturity fixed-rate bonds, there is the added benefit of a higher yield and less downside from a price perspective in a rising rate environment. When considering floating-rate bonds, remember that if the yield for a given bond does not look attractive enough, investors should be able to achieve a higher spread if they are willing to accept a bond with a lower rate cap.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP