CMO Market Update
October 28, 2019
Nominal spreads for Agency CMOs have widended marginally since our last update on October 15. In that time, yields have increased 5-6 basis points for the 3, 5, and 10-year Treasurys. This leaves CMO spreads at or near the high end of their range for 2019.
As noted in our monthly MBS Prepay Commentary, we continue to observe elevated prepayment speeds and it is likely for speeds to increase again next month. Given this environment, investors active in the CMO sector may want to consider cut-down coupons (e.g. 3.5 coupon off of 4.0 collateral) to lower the price and risk to underperforming yields.
Next week, we will examine the Monthly Trade Summary for October. It will be interesting to see the breakdown of trades by class type. As discussed in last month’s Trade Summary, September saw an uptick in VADM activity, accounting for nearly 15% of trades. This was a notable increase after a quiet couple of months for the product type.
Last call on the September Trade Summary for those that missed it:
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