Interest Rates, a Downer for Banks, Prove a Boon to Trading
18 April 2016 - 7:59PM
Dow Jones News
By Ben Eisen
Big U.S. banks have bemoaned low interest rates for years, but
instruments linked to those rates have recently proven to be one of
the few strong spots for their trading businesses.
Rates trading, which typically encompasses government bonds and
derivatives, was up at J.P. Morgan Chase & Co., Bank of America
Corp., and Citigroup Inc. during the first three months of the
year. The rise is a bright spot in an otherwise declining category;
major banks have seen a multiyear slide in revenue from trading
fixed income, commodities, and currencies, which includes
rates.
The rise reflects a jump in interest-rate volatility during the
first quarter as investors grew worried about a global economic
slowdown. A flurry of trading pushed the yield on the benchmark
10-year U.S. Treasury note down more than half a percentage point
in January and February to as low as 1.64%.
The increase is also a sign of the new regime for trading as
regulations make it more difficult for banks to hold bonds on their
balance sheets, making them more reliant on facilitating trades for
clients. That revenue is now more dependent on high volumes because
traders can no longer harvest big gains from making their own large
bets on the direction of interest rates, analysts say.
The banks don't break out revenue for rates trading. But last
year's first quarter is an indicator of what performance could look
like for the same period this year because they had similar
volatility. Revenue from trading rates of G-10 countries jumped 17%
that quarter from a year earlier, according to research firm
Coalition, which compiles trading data from the largest banks.
Interest-rate volatility climbed at the beginning of last year amid
a series of European Central Bank stimulus measures.
Volatility in U.S. interest rates increases the revenue of
stateside banks the most, according to George Kuznetsov, head of
research and analysis at Coalition. Chicago Board Options
Exchange's index of 10-year Treasury volatility climbed by more
than 50% between the end of December and its recent peak on Feb
11.
"For those banks particularly, the U.S. market is a very
important market where they tend to be better," Mr. Kuznetsov said.
"U.S. banks tend to be strong in the U.S. rates market compared to
international."
Citigroup on Friday cited "growth in rates [and] currencies,"
despite an 11% quarterly drop in debt trading over the previous
year.
Bank of America said Thursday that sales and trading revenue in
its fixed income, currencies and commodities group dropped 17% in
the latest quarter from a year earlier due partly to low interest
rates. But the "weak trading environment" for credit products and
foreign exchange was "partially offset by improved performance in
rates and client financing."
J.P. Morgan said Wednesday that its fixed-income markets revenue
was down 13% in first three months of the year from the same
quarter in 2015, but it would have been worse if not for "an
increase in the Rates business."
Morgan Stanley is set to release earnings on Monday and Goldman
Sachs Group Inc. on Tuesday.
It has become more difficult for banks to hold large amounts of
debt on their balance sheets, raising concerns about whether it has
become more difficult to transact in the deepest government-bond
market in the world. That became a prominent concern on Wall
Street, particularly after a "flash crash" in U.S. Treasury yields
in October 2014.
But the market for U.S. Treasurys is changing. Constrained
balance sheets are pushing banks to hold fewer bonds and instead
act as facilitators of big trades, according to Kevin McPartland,
head of market structure and technology at Greenwich
Associates.
In that environment, making money in rates trading is more about
volume than making big directional bets on the path of interest
rates. The burst of trading that pushed up interest-rate volatility
provided much of that volume, he said.
"There's a huge cyclical component here," Mr. McPartland said.
"If the markets come back to life a bit, that should buffer the
impact of the regulatory changes that hurt these businesses."
(END) Dow Jones Newswires
April 18, 2016 05:44 ET (09:44 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.
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