CMO Market Update

March 9, 2020

The Trade Desk saw steady one-way flow last week with bonds primarily going out to customers. There was good activity in 3.0% off of 3.0% front Sequentials.

Like other spread products, the CMO space saw notable widening last week. This shouldn’t be a surprise, however, with the precipitous drop in Treasury yields. While greater relative pick-up to benchmark bonds is attractive, it is difficult to digest absolute yield levels. As shown in the February Trade Summary Analytics below, near the end of 2019 customers were still purchasing projected yields greater than 2.0%, on average, to close out the year. And that was for bonds with about a 3 year WAL. We dipped below the 2.0% threshold last month, with an average yield of 1.67%. Needless to say, investors will be hard pressed to match February levels going forward, even when extending out to 5 years and beyond, and it will likely come with a sizable premium. However, spreads are monitored for a reason and when considering investment alternatives, CMOs have something to offer in the midst of this market movement.

In case you missed it last week, please find the February Trade Summary below.

February Trade Summary

Customers stuck to their game plan investing in CMOs with a WAL of around 3 years and an Effective Duration of 2. There was a slight shift towards bonds with less negative convexity, which makes sense in this environment. All else equal, more negative convexity translates to a less favorable price/yield relationship, i.e. less upside in terms of price appreciation when rates fall.

The biggest change month-over-month is the average projected yield that investors purchased. On average, customers purchased yields below 2.0%. And yet, spreads are wider than they have been in recent years. So, while absolute yield numbers may not seem attractive, the relative pickup still grabs the attention of investors.

Lastly, moving on to bond characteristics, investors focused solely on fixed rate bonds. And in terms of class type, Sequentials saw the most activity, accounting for 67% of trades.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks IBG, LP

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