CMO Market Update
March 22, 2021
With treasury yields rising, investors are mindful of extension risk and continue to express an aversion to high premiums. As a result, cut-coupon CMOs were back in focus last week in the fixed-rate space. The 1.00% – 1.50% part of the coupon stack was most active, primarily off of traditional collateral, with some low-loan balance and jumbo collateral trading as well.
As discussed in last week’s update, market participants are already weighing if Treasury yields have seen the majority of their movement for the time being. It has been approximately 3 years since we last saw the 10-year treasury yield increase for 7 consecutive weeks, a streak we are currently watching unfold. The market will determine where rates settle, but as of this writing the 10-year is off last week’s close by a couple basis points.
Spreads to Treasury yields for fixed-rate CMOs widened 2 basis points last week. Below is a condensed version (TSYs and CMOs only) of the Treasury Yield and Spread Snapshot from the overall commentary. As you can see, there hasn’t been much spread movement for CMOs year-to-date, but the year-over-year changes are drastic, as they are for all sectors.
Monthly Trade Summary
Treasury yields increased meaningfully in February, specifically on the long-end of the curve with the 10-year finishing just above 1.40% last week. With spreads holding up well for Agency CMOs, projected yields on customer purchases increased again month-over-month, with the average breaching 1.00% in February. Customers extending out on the curve and slower prepayment projections (although still generally elevated) contributed to a 3.5yr average WAL for fixed-rate investments, a slight increase over January.
However, rising rates was the story of the month and floating-rate product was in high demand. 20% of trades involved floating-rate bonds, a number more in line with November and October of last year. Supply is scarce otherwise this number would have been higher.
In terms of class type, PACs have now accounted for greater than 50% of trades in 3 out of the last 4 months.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP