Fat Trading

Let the Bond Times Roll

Higher rates and unpredictability are a good recipe for fixed-income traders.
At Closing, April 25th
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At Closing, April 25th
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Wall Street banks are having a great time delivering their fourth-quarter earnings reports.

Significantly higher revenues? Check. A revival of bond-trading profits? Check. A disciplined approach to compensation? Check.

And it looks as if the good times are going to continue to roll for a while, at least when it comes to lucrative debt-trading business. No wonder executives from Jamie Dimon to James Gorman sound so optimistic these days. Even Credit Suisse's battered chief executive has sounded a positive note.

Three of the most active trading houses, JPMorgan, Bank of America and Morgan Stanley, have already reported earnings, and just based on their shares, investors are relatively satisfied. These firms delivered a combined 40 percent gain in debt-trading results, with revenue 9 percent better than expected, as pointed out by Bloomberg Intelligence's Alison Williams.

Big Money

Debt-trading income accounts for a significant proportion of revenue at the largest global banks

Source: Bloomberg Intelligence

Note: All values are excluding valuation adjustments

The three banks posted almost $7 billion in bond-trading revenue in the three months ended Dec. 31, a traditionally sleepy time during which investors typically pack up their books and cut back their bold bets. But not this time.

Markets were sent into a tizzy after Donald Trump's election as the next U.S. president, with traders betting on more growth, higher benchmark borrowing costs and unpredictable policies. But Trump's ascendance to power, and the subsequent market volatility, is not the only reason for the increased activity, nor is it just a one-time boost.

The Federal Reserve raised interest rates for the second time in about a decade in December and pointed to several more rate increases this year. This has led to considerable disagreement about whether the bull market in bonds has already ended or whether investors are overly optimistic about economic expansion and subsequent increases in borrowing costs.

Higher Rates

Benchmark borrowing costs have risen in tandem with expectations for inflation and fiscal stimulus

Source: Bloomberg

Disagreement is beneficial for bond traders, especially when paired with higher interest rates. It means investors will line up on opposing sides. They'll feel compelled to move around their holdings because they think they can gain an edge. And there's generally more yield available, which typically translates to higher profit margins for traders.

Goldman Sachs and Citigroup are poised to report their earnings later this week, and they are broadly expected to be similarly positive to those at JPMorgan, Bank of America and Morgan Stanley.

Taking a look at trading volumes in the first few weeks of 2017, it appears that the higher levels of activity are here to stay. Average daily trading in U.S. company bonds has been 18 percent higher so far in January than in the same period last year, while Treasury volumes have been 8 percent higher in the first week of the year compared with those in the same period in 2016.

Trade Surge

Corporate-bond trading volumes have been higher this year compared with those in the same period in 2016

Source: Finra's Trace

Data refers to average daily trading volumes

Bond-trading revenues are notoriously fickle, but it appears that last year's surge in fixed-income profits has continued into the new year. It may be just as much fun for bank executives to deliver their first quarter results as it has been for them to talk about their fourth-quarter ones.

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

    To contact the author of this story:
    Lisa Abramowicz in New York at labramowicz@bloomberg.net

    To contact the editor responsible for this story:
    Daniel Niemi at dniemi1@bloomberg.net

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