CMO Market Update
March 25, 2019
For the third consecutive week CMO spreads widened 2 basis points. While spreads for longer Sequentials and PACs extended their highs since 2018, 3 year PACs have just reached a high watermark over the same time period.
As alluded to in last week’s commentary, customers looking for short, front Sequentials might want to consider coupon “cuts”, bonds with coupons different than that of the underlying collateral. There is a trade-off, of course. A lower cut leaves an investor susceptible to greater price risk in rising rate scenarios. Conversely, a lower cut projects to have greater price appreciation in falling rate scenarios than do higher cuts. This second point may be of particular interest to customers given the current market sentiment regarding the direction of rates.
Below you will find a comparison of 3 CMO bonds, each with the same underlying collateral: 30 year 4.5’s. The bonds are sorted by coupon, low to high, accompanied with analytics provided by Yield Book. As you can see, the lowest cut, bond 1, exhibits the price volatility behavior mentioned above. At current market levels, the 4.5 coupon of bond 3 is an example of an option which investors might want to avoid given recent volatility.
Next week, we will look at the monthly trade summary for March.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP