Higher volatility in the first two months, driven by uncertainty about the pace of Federal Reserve interest rate rises this year and next, has been exactly the kind that banks like best: sufficient to provoke a revival in volume of trades among clients taking divergent views; not so severe as to leave them too scared to do anything.
That’s a help to all banks’ market sales and trading businesses which are now almost entirely driven by client activity levels rather than proprietary position taking, other than that by being essentially long of inventory, most benefit from the rising book value of stock held for sale in bull markets.
Tushar Morzaria, chief financial officer of Barclays, noted at the announcement of 2017 results in late February “that income in the CIB markets business is up year-to-date compared to the corresponding period last year, both in dollars and in sterling.”
Tidjane Thiam, chief executive of Credit Suisse, also told analysts that global markets businesses have seen a strong start to the first quarter, with estimated revenues up more than 10% in the first six weeks of 2018 compared with the same period last year. Thiam particularly marked out the Swiss bank’s equities markets and securitization businesses as early beneficiaries of heightened volatility so far this year
That is a big relief also for people working in those fixed income, foreign exchange, credit and commodities businesses because in the second half of last year revenues went into the freezer.
However, few sources Euromoney speaks to are celebrating yet.
Last year, after a great first quarter boosted by the so-called Trump trade, FICC went on to underperform badly, with annual revenues across the industry down by 10% in credit, 12% in G10 rates and 21% in G10 FX, according to Coalition.
The start of this year looks very similar to the start of last, and what followed in 2017 was horrible. Traders must hope that volatility stays high, although within a fairly narrow and benign bound, so maintaining higher volumes, because underlying spread compression has not eased at all.
Traders report that spreads have never been tighter in cleared swaps and that in the actively traded government bond and inflation markets transactions are clearing around the mid-price.
It has not quite reached the point when traders are telling their bosses that they lose money on every trade but not to worry because they are doing a lot more of them. However, in the words of one global trading head: “Many of these sums no longer add up.”
The pessimistic view is that FICC trading remains a business too many banks are still throwing too much of their shareholders’ capital at and failing them in the process.
The only hope for returns to improve consistently above cost of capital – rather than hitting that basic requirement for maybe one quarter in every four – is for more banks to withdraw.
But banking is a business for optimists. Reasons for hope centre on structural change in the markets. Some market participants suggest clearing will spread further through the FICC businesses, beyond interest-rate swaps and into the cash markets themselves. This might allow banks to support higher trading volumes by turning over a much more limited sliver of dedicated capital at higher velocity.
Blockchain, or distributed ledger, is the other potential means to cut costs on which many FICC trading chiefs still pin their hopes.
Experiments within banks and between banks have been going on for several years now to create networks where a utility coin can tokenize traded financial assets, so making settlement close to instantaneous.
Axel Weber, chairman of UBS, is the senior banker who called out the potential most enthusiastically, when he declared at the IIF meetings in Washington: “With these blockchain technologies, if you can settle in two hours instead of two days, you can turn over balance sheet in the same activity 24 times – just imagine the profitability that this will bring to financial institutions that are payment and transaction focused – this is a huge opportunity.”
That was back in 2015, however.
Enthusiasm for blockchain has dimmed in the last year or so. If it is ever to deliver on its hopes for markets business, something big has to emerge soon.