CMO Market Update

November 15, 2021

The trade desk saw lighter flows again last week in the CMO space. One structure that received decent demand was 1.5% coupon sequentials off 2.5% – 3.0%, New York collateral.  Additionally, some investors looked to higher cuts, primarily 3.0% off low loan balance, 100% Florida collateral. For more information on prepayments and collateral types, please see our Novemeber MBS Prepay Commentary.

In terms of yields and spreads, Treasury rates continue to rise and most significantly in the 3-5 year part of the curve. Just last week, the 3- and 5-year Treasury bonds increased 19 and 16 basis points in yield, respectively. This is of course the portion of the curve in which our customers typically traffic. While nominal CMO spreads have tightened on a year-to-date basis, they have held up well in relation to the rise in benchmark yields. As a result, projected yields look attractive in the agency CMO space relative to the last 18 months.

The Treasury and CMO sections from last week’s Investment Alternatives Matrix are shown below. To reiterate, yields rose strongly to finish the week, and are rising again this morning. As of this writing, the 3-, 5-, and 10-year Treasurys yield 0.858%, 1.251%, and 1.615%, respectively.

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Monthly Trade Summary

This week, we will focus on summary analytics for CMO trades executed in October. Yields for the 2-, 3-, and 5-year Treasury each increased more than 20 basis points during the month. As regular readers know, this is the portion of the curve in which our customers typically traffic in the CMO space. Given how steady CMO spreads have been, it is no surprise that projected yields on new purchases last month increased by roughly the same amount as their comparable maturity Treasury.

Investors extended out slightly in October with fixed-rate purchases averaging a 4.1 year WAL, up from 3.8 and 3.1 the two prior months, but right in line with June and May data. From a yield perspective, investors benefited greatly by extending out only marginally to earn a projected 20+ additional basis points. Last month’s average projected yield of 1.46% is the highest monthly average we have seen since February of 2020, when the average yield purchased was 1.67%.

While there was some floating-rate activity last month, fixed-rate bonds accounted for the overwhelming majority of trades at 95%. When looking at class type/structure, investor buying behavior in October was very similar to what we’ve seen in recent months. PACs continue to account for the most trades in this sector, averaging around 60% over the last 4 months.

Lastly, a few words on coupons. Customers have been most engaged with lower coupon cuts in this space. Generally speaking, that has meant 1.00% – 1.25% cuts during the early part of the year. As rates have increased, more investors are looking to 1.50% coupons as prices have declined and can generally be found at slight discount to par handle dollar prices.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks

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