The fourth quarter of 2019 saw an unexpected bonanza in debt trading for banks. JPMorgan’s fixed income revenue of $3.4 billion marked a rise of 86% compared with the same quarter in 2018, while Morgan Stanley saw an increase of 126% to $1.27 billion.
JPMorgan’s chief financial officer Jennifer Piepszak had the grace to acknowledge that a surge in liquidity provision by the Federal Reserve contributed to the bumper quarter.
“The Fed balance sheet extension was for sure a tailwind for us,” Piepszak said.
Morgan Stanley’s chief executive James Gorman was more inclined to take credit for the bank’s strong results and berated stock analysts for once doubting his ability to deliver improved returns on equity.
Morgan Stanley’s markets revenues – and stock price – have actually been fairly closely correlated to the increase in the Federal Reserve balance sheet recently.
This may be a coincidence or it may reflect the extent to which central bank liquidity provision translates to improved revenues for a firm with a bias towards areas of fixed income such as securitized products and leveraged finance.
The proximate cause of the latest wave of Federal Reserve balance sheet expansion was a disruption in the repo markets in September 2019, when short-term rates had a brief but dramatic spike.
Repo market dislocation in 2007 has become seen in retrospect as a harbinger of the global financial crisis of 2008, which prompted regulators to swiftly address the more recent signs of stress.
The Federal Reserve announced that it would resume repo market intervention soon after the September 2019 rate spike, in the first move of its type since 2008. It remained active in the market at the beginning of this year. This successfully calmed repo market nerves, including around year end, when liquidity is often constrained, but also increased the size of the Federal Reserve balance sheet by close to $500 billion.
The Fed had been pursuing a policy of shrinking its balance sheet for almost two years before the repo market stress, with a reduction to under $3.8 trillion by August 2019. This was firmly below the highest level yet seen of $4.5 trillion in 2015 but well above the $870 billion of total assets in August 2007, just before the global financial crisis.
US central bankers have been keen to portray their recent intervention as simply a move to ensure that the plumbing of the financial markets is working efficiently. Fed officials have strenuously denied that the balance sheet expansion constitutes another wave of quantitative easing (QE).
The Federal Reserve denial that an informal QE4 is under way is one of a number of overlapping narratives that are accompanying the balance sheet expansion.
Soon after the repo market stress in September, JPMorgan chief executive Jamie Dimon blamed post-crisis regulations for forcing his bank to hold reserves at such a high level that it was unable to bring down rates on its own.
Dimon was not positing altruistic motives for his bank or rival firms. Indeed his argument had some plausibility, as there does seem to have been reluctance on the part of big dealers to take advantage of the brief spike in repo rates to levels between 6% and 10% in order to make a trading profit.
In retrospect, it seems that Dimon and his peers made the right call from a standpoint of self-interest by standing aside so that regulators could calm the repo market on their behalf. The subsequent provision of liquidity by the Federal Reserve was a factor in a much bigger recovery in revenue than would have been generated by some opportunistic trades when repo rates were briefly elevated.
Even if JPMorgan is reluctant to talk too openly about its recent trading bonanza, one man can be relied upon to avoid understatement in any form
JPMorgan’s fixed income revenue in the fourth quarter of 2019 was $1.59 billion higher than in the same period in 2018 (which had seen weak performance across the industry). The increase in absolute terms reflects the extent to which regulatory moves that boost trading revenues reward banks that have scale.
This is serving to widen even further the gap between the biggest US banks and their European counterparts.
UBS, for example, saw an increase in fourth quarter 2019 revenue in its rates and credit businesses that was even more impressive than the overall fixed income growth for JPMorgan and Morgan Stanley on a percentage basis – with a rise of 362% compared with the same period in 2018.
But UBS is now reliant on foreign exchange revenue in its slimmed down fixed income group and low volatility affected currency trading income. Even after a boost from rates and credit trading, UBS still only generated $352 million of revenue in fixed income during the quarter, which was less than 25% of the quarterly increase for JPMorgan and barely 10% of the total for the US bank.
JPMorgan made another understated admission of help from the Federal Reserve, beyond the hat-tip from Piepszak on the earnings call with analysts. A line in its earnings release referred to the bank’s growth in securitized products and rates revenue being “driven by strong client activity and monetizing flows”.í
The act of “monetizing flows” can be viewed as embedded proprietary dealing or simply a benefit of high share in a market with increased volumes, depending on your perspective.
Even if JPMorgan is reluctant to talk too openly about its recent trading bonanza, one man can be relied upon to avoid understatement in any form.
The day after JPMorgan announced its strong fourth quarter, along with a record full year for both revenues and profit for any US bank, business leaders were summoned to the White House to watch a signing ceremony for the first phase of a tentative trade agreement with China.
President Trump singled out Mary Erdoes, head of asset and wealth management at JPMorgan, for attention.
“They (JPM) just announced earnings and they were incredible. They were very substantial. Will you say ‘thank you Mr President’ at least?” Trump demanded.
He then instructed Erdoes to “say hello” to Jamie Dimon, who had managed to find a more pressing engagement that day.
Trump likes to take credit for any success, but in this case he was probably thinking that his relentless pressure on the Federal Reserve to ease monetary conditions had helped JPMorgan and he may well have been right.
The Federal Reserve had a logical reason to flood the markets with liquidity at the end of last year due to the repo disruption, but the balance sheet expansion also helped to ease political pressure from Trump because other effects included a renewed stock rally and beneficial fixed income trading conditions for big banks.
Dimon hailed the “Goldilocks” economic conditions that currently prevail in an appearance at Davos in January and for now business leaders, Federal Reserve officials and Trump can all act like they are pals of a sort.
Regulators may worry privately that they are introducing a liquidity put for banks and other trading firms comparable to the Greenspan put created by the former Federal Reserve chairman that buoyed markets before a cataclysmic crash in 2008.
But for now the good times continue to roll.