CMO Market Update
June 8, 2020
Traders saw a slow start to the week before very active sessions Wednesday through Friday. Activity was dominated by one way flow with customers investing outright from cash. Prepayments and called bonds continue to serve as sources of funds in this low rate environment.
This week we will review May activity with the monthly 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