CMO Market Update
March 7, 2022
Activity was lighter than usual last week in the Agency CMO space. Of the trades that were executed, 2.25% – 2.50% coupon cuts were in the highest demand, with FNCL and G2SF 3.5 the predominant collateral types.
As the calendar has turned to March, the end of Q1 is in sight and there has been no shortage of meaningful market movements. Some developing trends that investors are sure to keep their eyes on: rising yields, higher coupons, and tightening spreads.
As experienced by the bond market overall, yields have risen precipitously to begin the year. This has been most notable at the front end of the curve with market participants adjusting expectations for future rate hikes from the Fed. The sell off has made prices more attractive for 2.50% – 3.00% cuts, and thus investors are moving up the coupon stack. A reminder that for most of the pandemic, the focus area in Agency CMOs was 1.00% – 2.00% cuts. And although absolute yields are as attractive as they have been in 2 years, rising benchmark yields have led to tightening nominal spreads.
Below is the monthly trade summary for February.
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