CMO Market Update

October 15, 2019

Last week’s CMO update focused on the Monthly Trade Summary, which noted an uptick in VADM activity seen during September. Investors typically consider VADMs to limit extension risk. While economic projections still favor additional Fed easing, it is less expensive to prepare for risk in advance. And it just so happens that Treasury yields increased nearly 20bps across the curve last week.

With Treasury yields rising notably last week, CMO spreads tightened in about 2 basis points. CMOs continue to offer improved relative value compared to where the sector started 2019. As shown in the Yield and Spread Snapshot from the Overall Commentary, nominal spreads have widened 20-30 basis points this year for Agency PACs and Sequentials.

For those who missed the monthly Trade Summary last week, please find it below.

September Trade Summary

Although Treasurys maturing in 1 to 6 months declined in yield during September, yields increased for the intermediate and longer portion of the curve. The 2- through 10-year Treasury yields rose between 17 and 22 basis points. Consequently, Agency CMOs purchased last month are projected to yield more than those bought in August. Duration, Convexity, and Weighted Average Lives of investments were consistent with previous months.

The one notable change month-over-month was VADM activity, accounting for 14% of trades. While this isn’t a huge number, it does exceed what we’ve seen for the previous four months. As has been discussed in past updates, if expectations reverse and rising rates become a concern, investors may consider VADMs to avoid extension risk.

Three out of the last four months have seen a roughly equal distribution in trades between Sequentials and PACs. This contrasts with the end of 2018 and start to 2019 when Sequentials tended to dominate activity.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks IBG, LP

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