CMO Market Update

September 16, 2019

We are two weeks into September and Treasury yields are notably higher from the end of August. There was a slight uptick in yields for the week ending September 6th, but last week saw a substantial move. Yields for intermediate- and longer-maturity Treasurys increased by more than 30 basis points. And yet CMO spreads tightened only marginally. 5-year PACs and Sequentials gave up 2 basis points of spread. Spreads for 10-year bonds tightened by 1 basis point.

As shown in the August Trade Summary from last week’s CMO update, Customers continue to invest in shorter CMOs with a projected WAL of around 3 years. By our estimation, CMOs in the 3-year space still offer attractive spread, within 5 basis points of 2019 highs reached in late August.

Also touched on in the Trade Summary, VADM activity has dropped off from the beginning of the year. It was noted that if sentiment were to shift, investors may consider that product to manage extension risk. While it’s probably not fair to say rate expectations have reversed, the bond market has taken back some of the rally from this summer. It just goes to show how quickly conditions can change and why it’s important to manage the portfolio accordingly before risks are realized.

If you missed it last week, please find the August Trade Summary below.

August Trade Summary

Investors were very engaged in the CMO sector during August. Yields purchased dropped for fixed rate bonds, which is not surprising given the way Treasurys have declined. However, CMO spreads are still within arm’s reach of 2019 highs measured in June.

As is usually the case, fixed-rate buying dominated. With rates so low in general, it’s not surprising to see VADMs accounting for such few trades. However, if sentiment were to shift and rate expectations reverse, investors may look to that product type for more predictable cashflows if extension risk becomes a more likely concern. Another trend we are seeing, although not captured in the trade summary below, is more investing in “cut-coupons”.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks IBG, LP

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