For US banks' bond trading desks, the Federal Reserve just made a bad quarter even worse, accentuating a longer-term decline in what was once their most lucrative business, executives, analysts and traders told Reuters. Bond trading volume is likely to drop globally in the coming weeks, after the Fed decided on Thursday to keep rates unchanged. Many investors are reluctant to take too much risk in bonds and related derivatives until they have a better sense of when the US central bank will start hiking rates, traders said.
"The market is queasy, and is not taking bad news well," said Michael Sobel, managing partner at TruMid, an electronic trading platform for corporate bonds, and former head of junk bond trading at Barclays. It is harder to get some trades done, he added. Weaker bond trading results will weigh on the bottom line at major banks, which can get as much as a third of their revenue from the business, and have already been hit by low interest rates and tepid demand for many kinds of loans. Some analysts already had been reducing their earnings estimates for banks over the last month. For Goldman Sachs Group Inc, for example, three analysts have cut estimates over the last 30 days, by an average of nearly 6 percent.
The quarter was tough for bank trading revenue even before the Fed announcement. The Greek debt crisis kept many investors out of markets entirely, and China's slowing growth resulted in the kind of steep market movements that hurt profits for many traders. Generally, banks do best when there's a degree of uncertainty, which spurs investors to reposition their portfolios. But when events become completely unpredictable, and markets move wildly, trading volume can dry up, analysts said. "Banks are getting the bad kind of volatility now," said Charles Peabody, a veteran banking analyst at Portales Partners in New York.
Chief executives from Citigroup, Bank of America Corp , and J.P. Morgan Chase & Co, speaking at a Barclays conference, all said this week that their overall trading revenue is likely to fall by around 5 percent in the current quarter. Bank of America CEO Brian Moynihan blamed the drop mainly on weaker bond trading results, which he said were partly offset by stronger stock trading.
Jefferies Group, an investment bank that is part of the Leucadia National Corp conglomerate, said on Thursday that a measure of its earnings plunged by nearly 50 percent thanks to slow bond trading and big writedowns on distressed debt tied to the energy industry. Bond trading revenue has been falling at major banks since the financial crisis, as banks have been barred by regulators from making big market bets with their own money. Coalition, an investment banking consulting firm, estimates annual industry revenue from bond trading at around $70 billion, about half its level in 2009.
In the last few years, revenue has been stabilizing, and results from the business still occasionally jump. In the first quarter of this year, for example, bond trading revenue surged at most major banks, as the Swiss central bank scrapped a cap on the franc, the Fed seemed likely to tighten monetary policy soon, and the European Central Bank announced a quantitative easing program.
Morgan Stanley posted bond trading revenue of $1.9 billion, a 15 percent gain from the same period last year and its highest level in three years. But times have changed, and with this week's Fed move, a source at a major investment bank said his customers are in limbo now. "There would definitely be more client activity if they had raised rates," he said.
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