The Fixed-Income Conundrum

One firm's fixed-income pain could be another's gain.
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Morgan Stanley just became the latest firm to plan huge cuts to its fixed-income staff, and that may be music to the ears of Goldman Sachs. But it can't be a very relaxing song to hear. 

Both firms, along with most Wall Street companies, reported large declines in trading in fixed income, currency and commodities last quarter. For Morgan Stanley, the response is to eliminate as much as a quarter of its fixed-income employees, Bloomberg News reported on Monday, citing people with knowledge of the plans. It joins UBS, Deutsche Bank and Barclays in making reductions. 

Rough Quarter

Trading revenue in fixed income, currencies and commodities fell significantly for most banks last quarter.

Source: Bloomberg Intelligence

Note: BAC, JPM figures are on a pro-forma basis.

Goldman, on the other hand, appears to be standing firm despite a 34 percent drop in third-quarter bond-trading revenue that left earnings short of analysts' estimates for the first time in four years. Not that the firm's fixed-income staff has been unscathed -- Chief Financial Officer Harvey Schwartz has said that head count has shrunk by more than 10 percent since 2013 as Goldman cut risk-weighted assets by more than a third to comply with new capital requirements. Yet analysts have repeatedly questioned whether the firm should be more aggressive in trimming down the business.  

Colm Kelleher, the head of Morgan Stanley's investment banking and trading division, estimated that annual global fees in fixed income were historically in the neighborhood of $150 billion to $160 billion and have fallen to $100 billion or less in the last three years.  There are plenty of reasons cited for the slump: subdued trading as major central banks pin interest rates near zero;  the disposal of inventories of riskier assets to meet stricter capital requirements; and the move toward more computerized trading, to name a few. Because banks report very little in the way of official numbers from their FICC traders, it's anyone's guess what exactly is contributing the most.   

So while it's obvious that fixed-income revenue has been in serious decline, how much of the slump is permanent versus a temporary shift is open to debate. And that debate also draws an interesting contrast between the strategies of Morgan Stanley and Goldman Sachs. 

Waiting Game

Goldman Sachs is poised to pick up market share if FICC trading rebounds.

Source: Bloomberg

Kelleher said recently that in a very long cycle, "you have to reduce the cost of optionality" and size the business appropriately while reserving some flexibility for when markets recover.  Schwartz, on the other hand, has compared the trading cycle to trends in mergers and acquisitions. Some thought the M&A boom was dead after the financial crisis, but it recovered and takeovers this year are back at a record

So as Morgan Stanley and others cut their bond-trading staffs, Goldman may want to lie in wait in hopes of picking up market share if -- and when -- the business picks back up. Goldman's "optionality" may be getting expensive, but then again there's not much more time to wait to see what effect higher interest rates will have on trading. It could prove to be a risky move for Goldman. But with a 9.4 percent return on equity that's almost twice Morgan Stanley's, it's one Goldman can afford and one that could very well pay off. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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    Michael P. Regan in New York at

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