CMO Market Update
June 22, 2020
Spreads to Treasury yields for fixed-rate CMOs continue to grind tighter, shaving 2 basis points last week, but remain wider by 10-20 basis points year-to-date.
In terms of activity, short, lower-coupon front sequentials consistently generate interest from investors. More specifically, many customers are seeking 2.0% or lower cuts, with some going as low as 1.25%. While the spread pickup is not as generous as longer, higher-coupon bonds, customers aim to benefit from greater prepay protection, as well as lower dollar prices. As mentioned in previous CMO updates, dollar prices are high in general, and some investors are expressing an aversion to mid or high premiums given the low-rate environment.
Trades have been defined by primarily one-way flow with investors buying bonds outright from cash as called bonds and prepayments continue to provide customers with a source of funds. With that said, the Trade Desk is actively seeking bid lists as some customers might look to clean up smaller positions or possibly take some gains.
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. 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 lower 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