Wall Street Facing Drop in Trading Look to Fed for ReliefMichael J. Moore
Wall Street banks, facing a drop in third-quarter trading revenue, are counting on today’s Federal Reserve announcement to spark a surge in volume.
Banks including JPMorgan Chase & Co. and Barclays Plc have indicated to investors that trading revenue for the period probably will be down from a year earlier. Jefferies Group LLC, whose third quarter ended in August, said yesterday that fixed-income trading revenue plunged 88 percent while equity trading fell 28 percent.
Investors had been waiting to see whether the U.S. central bank will begin reducing its $85 billion in monthly bond purchases. The Fed unexpectedly refrained from reducing the pace of buying, saying today that it needs to see more signs of lasting economic improvement. The decision could boost trading as investors make adjustments to their portfolios, according to Brad Hintz, a Sanford C. Bernstein & Co. analyst.
“I don’t want to write the quarter off yet,” Hintz, who’s based in New York, said before the Fed announcement. “July and August were not particularly strong months, and this is going to be one where to find out how the quarter turns out, we’re going to have to actually wait until the very end of the quarter.”
Last year, traders speculated about whether the central bank would increase the stimulus, which it did in September. Fed Chairman Ben S. Bernanke said today that a decision on tapering asset purchases depends on economic data, and there is no set timetable.
While the decision could increase volatility and volume in the next couple weeks, any revenue gains may not be enough to fully offset the performance of the first two months, said Devin Ryan, a bank analyst at JMP Group Inc. When rates do start to rise, that could also lead to a boost in trading revenue, provided the increase isn’t too quick, he said.
The Fed’s actions “will continue to be top of conversation,” Ryan said. “As rates do begin to move up in the future, that could be a positive for trading activity. The key is higher rates within reason. If you have a jolt that catches people off-guard, that could lead to issues.”
The nine largest global investment banks generated $32.4 billion from trading stocks, bonds, currencies and other products in the second quarter, or 24 percent of total net revenue. The firms produced $70.9 billion in the first half, down 1.9 percent from the first six months of 2012.
Jefferies Chief Executive Officer Richard Handler, 52, said the firm suffered from “unsettled” fixed-income markets in June and “subdued summer activity levels” in July and August. The business “markedly improved” in September, he said.
“With the significant change in expectations regarding interest rates, we experienced a very challenging summer in our fixed-income businesses due to the rising rate environment, spread widening, redemptions experienced by our client base which heavily muted trading, and related mark-to-market writedowns within our inventory,” he said in a statement.
In the past two weeks, four analysts have cut their third-quarter earnings estimates for New York-based Goldman Sachs Group Inc., the bank most reliant on trading and investment-banking revenue. Other lenders have provided investors with warnings about trading.
“We have seen continued volatile fixed-income market conditions in July and August, which has exacerbated the normal seasonal slowdowns in trading volumes, and thus adversely impacted our fixed-income business,” Credit Suisse Group AG Chief Financial Officer David Mathers, 48, said Sept. 11.
Investors stepped aside after an increase in interest rates in June caused a jump in trading volume and losses for some bond investors, Hintz said. Bernanke said June 19 that policy makers may reduce the central bank’s purchases this year and halt them altogether by mid-2014 if the economy improves in line with officials’ expectations.
“We could see this higher-volume scenario unfold in the coming weeks as the Fed meeting on the 18th has the potential to introduce some volatility into the market in a variety of asset classes,” Roger Freeman, an analyst at Barclays, said in a Sept. 13 note to clients. “The back half of September has the potential to set the tone for volumes over the remainder of the year.”
A lack of trading in the first two months of the quarter may increase the importance of banks’ gains and losses on their inventory positions. The Bloomberg U.S. Corporate Bond Index, which measures the performance of investment-grade company debt, dropped 0.3 percent this quarter through yesterday, while the high-yield index climbed 2 percent. The Standard & Poor’s 500 Index is up 6.1 percent this quarter.
“A lot of the performance will have to do with how big the risk-taking was,” Hintz said. “The volumes aren’t going to drive the quarter. It’s going to be what kind of risk positions did you have on?’”
Barclays, the U.K.’s second-largest bank by assets, said a drop in stock and bond trading in July and August sparked a “significant” fall in revenue at its largest unit. The decline in fixed income, currencies and commodities at the investment bank helped shave 500 million pounds ($797 million) from the group’s adjusted revenue for the two months compared with 2012.
JPMorgan, the biggest U.S. bank, expects third-quarter revenue from stock and bond trading may decline as much as 5 percent from a year earlier, when it produced $4.77 billion.
Trading revenue is “tracking well versus the third quarter of last year, but September last year was particularly strong and we don’t expect it to be as strong as last year,” Marianne Lake, the bank’s CFO, said at an investor conference in New York on Sept. 9.
Morgan Stanley CFO Ruth Porat said the next day at the same conference that trading volume was “a bit lower” than the year-earlier period across the industry.
Daily trading of high-yield bonds is down 4.4 percent from the third quarter of 2012, while trading of investment-grade bonds is up 2.6 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Average daily volume for U.S. equities is 5.64 billion shares in the quarter, a drop of 5.5 percent from last year, according to data compiled by Bloomberg.
Trading may have gotten a boost from Verizon Communications Inc.’s record $49 billion bond offering last week. That helped global corporate-debt issuance mark its second-strongest week of the year, and the pickup is “broadly supportive” of brokers such as Goldman Sachs, Doug Sipkin, a New York-based analyst at Susquehanna Financial Group LLLP, wrote in a note this week.
A bigger bump may come from investors reacting to today’s Fed decision, Bernstein’s Hintz said. Bernanke has orchestrated the most aggressive easing in the Fed’s 100-year history, pumping up the balance sheet to $3.66 trillion from $869 billion in August 2007 and holding the main interest rate close to zero since December 2008.
“Fixed-income is a business of watching central banks,” he said. “Changing policies by central banks tend to be good for fixed-income, at least initially.”
Editors: Robert Friedman, David Scheer