Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

This was supposed to be the year that Wall Street regained its bond-trading mojo. And that did seem plausible during the initial weeks of the year -- but as the year dragged on and August crawled to an end, it's become abundantly clear that things are heading in the wrong direction for these units. 

Junk-bond trading, a traditional profit center for large banks, is becoming increasingly less active, with volumes falling year over year for the first time since 2011: 

About Face
Junk-bond volumes have fallen this year amid slower issuance and investor uncertainty
Source: Finra's Trace system, Bloomberg

Benchmark Treasury yields have fallen to 2017 lows in an undramatic way, with pretty much no expectations for volatility anytime in the near future:

What Yield?
Yields on 10-year U.S. Treasuries have fallen to the lowest levels of the year
Source: Bloomberg

Yields initially fell further Friday, after a disappointing U.S. jobs report threw yet another dose of cold water on the idea of an accelerating economic recovery. They eventually bounced up a bit on a day when most traders have already left for a long, last summer weekend at the beach, amid some signs of manufacturing strength. 

Meanwhile, longer-term borrowing costs have fallen relative to shorter-term ones, making it less lucrative for banks to lend.

Shrinkage
The gap between longer- and shorter-term yields has fallen, crimping potential bank profits
Source: Bloomberg

This is going to make for some difficult conversations in the next two weeks, as banks including Wells Fargo & Co., JPMorgan Chase & Co. and Citigroup Inc. give presentations to investors. Goldman Sachs Group Inc., which has followed a different path than some peers and publicly doubled down on its bond unit, is expected to detail its future plans for the business next month, a rather unusual step for the bank.

In these presentations, it'll be particularly interesting to hear how much banks are counting on regulatory rollbacks to boost profits. Policy makers are currently discussing how best to tweak banking rules. Goldman has been particularly aggressive, lobbying heavily in Washington for specific changes with much of the focus on the Volcker Rule, which prevents banks from making big wagers with their own money. This rule has specifically eaten into profitability for debt-trading units, since those businesses historically relied upon traders using capital to opportunistically buy and sell securities.

But not all regulatory changes are the same. While some changes would help bolster profits at debt units, others, like making the Dodd-Frank Act less onerous for smaller lenders, would have little effect. Meanwhile, given the rising acrimony among U.S. legislators, it's unclear how quickly any regulatory overhaul could get enacted, especially with several Federal Reserve members pushing back against some of the proposed changes.

Too Steady
Expectations of future volatility in U.S. Treasuries have basically died, based on this gauge
Source: Bloomberg, Merrill Lynch Option Volatility Estimate MOVE Index

Any regulatory changes aside, Wall Street banks seem stuck in the same bad movie they have suffered through for years when it comes to debt trading. The next few months will be crucial to see whether they remain optimistic about a resurgence in this business, or whether they're forced to pare back yet again.

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:
Beth Williams at bewilliams@bloomberg.net