CMO Market Update
October 18, 2021
Treasury yields continue to rise, particularly in the 3-5 year portion of the curve where our customers are most active in the CMO sector. As a result, traders observed CMO spreads tighten 2 basis points last week for fixed and floating-rate bonds. For the maturities and structures we monitor, CMO spreads have moved in a fairly narrow range year-to-date. 5-year bonds have experienced the biggest change, with Sequentials and PACs 6 and 9 basis points tighter on the year, respectively. As shown in the graph below, CMO spreads are at or near their tightest levels in 2021.
Most customer inquiries in this space continue to revolve around low coupon cuts. In terms of activity last week, investors honed in on 1.50% coupon bonds off both traditional and jumbo collateral. There was some modest floating-rate activity, but otherwise fixed-rate bonds continue to account for the majority of trades. As shown in the table below from last week’s Investment Alternatives Matrix, 1.00% to 1.50% cuts have generally been available at discount to par handle prices.
September Trade Summary
Treasury yields rose in September with the intermediate and longer end of the curve seeing the biggest changes. Yields for government bonds 3-years and out increased by more than 10 basis points. This market move contributed to higher yields for customer CMO purchases during the month. As shown in the table below, the average projected yield on new purchases was 1.20% in September, up 7 basis points from August, but right in line with the range we’ve seen for the past 5 months.
Investors extended out on the curve month-over-month as shown by a 3.8 year weighted-average-life (WAL), up from 3.1 in August. But again, this is in line with projections from the summer months, averaging about a 4 year WAL. The same story applies to effective duration.
Fixed-rate coupons continue to dominate activity, accounting for 90% of trades last month, while floating-rate bonds made up the remaining 10%. This would have been a very respectable number for floating-rate activity to start the year, but in the last 5 months it beats only July in which floating-rate activity was < 1% of trades.
Once again, and as has been the case for most of the year, investors continue to favor PACs when it comes to structure. June is the only month this year in which Sequentials have outpaced PACs.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP