It’s easy to dismiss banker optimism of brighter days ahead for debt trading as simply wishful thinking.
Wall Street banks have watched fixed-income earnings fall since the mortgage-debt crisis and its aftermath. They've responded by making sweeping staff cuts, yet profits keep dropping. So when JPMorgan Chase’s Daniel Pinto said on Wednesday that the end of the carnage is near, the instinct is to respond with a healthy amount of I’ll believe it when I see it.
But certain market developments suggest that perhaps Pinto is on to something.
Corporate-bond trading has increased substantially since the beginning of March, both on an absolute level as well as a proportion of outstanding debt. Average daily high-yield trading surged 18 percent since March 1 compared with activity in the period a year earlier, while investment-grade volumes rose 15 percent, Finra’s Trace data show.
This matters tremendously on Wall Street because banks typically earn more from brokering corporate credit, particularly riskier bonds and loans, than government bonds or stocks, both of which are often traded electronically. Corporate debt is still usually traded on the phone or in emails, off exchanges, with traders matching buyers and sellers and taking a commission for the effort.
This matters for investors on Main Street, too, because it marks the end of a predictable monetary policy environment and the rise of a fickle "insecure stability" in markets, pocked with unforeseen risks and sudden sinkholes. Trading is increasing in part because the world is changing, which creates a less-lopsided market and broader opportunities for big gains -- and losses.
When the Federal Reserve was alone in its stimulative monetary policies, it had a more obvious influence on markets. When it bought bonds, everyone else bought bonds, risky, safe, whatever. There was a feeding frenzy at nearly every corporate debt sale. Once investors got some bonds, they didn’t want to sell them because they didn’t know whether they’d get them back.
So trading slowed relative to the huge increase in outstanding debt, and brokering profits fell.
Now, the Fed is trying to move away from its stimulus, albeit slowly. But other central banks from Europe to Japan are still in full-blown, easy-money party time, sending droves of international investors into U.S. debt. Meanwhile, defaults are starting to pick up in the wake of lower oil prices, leading to some higher yields and thus bigger potential trading profits.
This new backdrop has made it a more confusing time to be a U.S. debt investor. Investors have increasingly disparate views on everything from interest-rate increases to inflation to the chance of recession. And that’s good for trading revenues, even if perhaps not fantastic for investors accustomed to the serenity of recent years.
Big U.S. banks are hoping this will be a lasting wave that they can dominate, especially while their European peers continue to retrench. Even if activity wanes, American firms are leaner than they once were and can ride out lulls in activity more cheaply.
JPMorgan cut fixed-income compensation by about 25 percent over the past five years, and headcount fell about 10 percent, not including entire units that were eliminated.
"It feels that probably we are getting toward the end of the cycle of contraction now," Pinto said Wednesday. "We are in a good position to face the next stage, when that comes."
Something new is in the air on trading desks. Banks aren't expecting the go-go days of yore to come back; they're just expecting a more normal flow of activity. This will continue to be unsettling for bond investors, but it will likely be a welcome change on Wall Street.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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