CMO Market Update
March 8, 2021
The end of this week will mark one year since the Fed cut their overnight target rate range by 100 bps to 0.00%-0.25%. It was the second emergency policy decision made in a two-week span as markets priced in the fear and uncertainty surrounding the global pandemic. CMO spreads to Treasury yields peaked around that time and have methodically tightened ever since. As benchmark yields have increased to begin this year, CMO spreads are just off their lows over the last twelve months.
The good news for CMO investors is that spreads have been resilient as the long end of the Treasury curve has risen. Depending on maturity and structure, spreads are within 2 basis points of where they started the year. So, from a yield perspective, CMOs are as attractive now as they have been in months. This is reflected in the monthly trade summary, found below, as the average projected yield on customer purchases was > 1.00% last month.
In terms of activity last week, trades picked up as the week progressed. Customers are still favoring cut-coupons in the fixed-rate space with a 3-5 year projected WAL in the base case. It will be interesting to see if demand for floating-rate bonds persists with yields having moved significantly thus far in the first quarter. Time will tell if there is more room to run.
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