CMO Market Update
March 14, 2022
Treasury yields pushed higher last week with 2- through 10-year benchmark bonds increasing 27-31 basis points depending on maturity. Among many noteworthy headlines, investors have all eyes on the Fed’s rate decision Wednesday. It seems like a short time ago a 50 basis point hike was a forgone conclusion. The market has since reduced expectations, with only a 25 basis point hike baked into the market.
Given the market setup, the CMO space remains attractive from a yield perspective. While slightly tighter year-to-date, spreads in this sector have held up well given the meaningful increases in Treasury yields, especially at the front and intermediate portion of the curve.
Activity last week was fairly diversified with a variety of structures and collateral types trading. We saw a slight uptick in floating-rate activity last month (see February trade summary below), and there was more again last week including SOFR-based instruments. In the fixed-rate space, both tradition and prepay friction collateral moved to customers. One structure that saw particular interest was a 2.5% coupon cut off 100% New York collateral.
Below is last week’s Investment Alternatives Matrix. To reiterate, Treasury yields are now meaningfully higher than shown in the snapshot below. It speaks to the volatility all investors face at the moment. As detailed in the monthly trade summary, projected yields on CMOs were greater than 2.0% on average in February. These levels figure to continue rising if the Fed is able to successfully lift rates from zero.
Monthly Trade Summary
As anticipated, the average projected yield on February CMO purchases breached the 2.0% threshold. Naturally, just as we have reached this psychological barrier, markets have taken a risk-off tone. There’s no way of knowing if we have reached a local top in terms of yields, so those that have remained active have done well to add to the portfolio at these levels.
Other risk/return metrics were in line month-over-month. In terms of structure, it was nearly an even split between Sequentials and PACs traded. This has oscillated back and forth for the last few months. As is usually the case, fixed-rate coupons dominated activity, although there was a slight uptick in floating-rate activity month-over month.
The average projected WAL shortened nearly half a year from January to February. It will be interesting to see what this measure looks like for March purchases given the risk-off sentiment that has taken hold.
Travis Nauert, CFA
Analyst, Investment Strategies