City bond traders have put the champagne on ice. They had a good run. For some it lasted almost a year. But it’s over now and the “new normal” of low trading volumes and weak profits is reasserting itself.
On Wall Street, Goldman Sachs took the biggest hit. This week the firm reported profits had plunged 40% in the second quarter on its bond, currency and commodities trading desks.
All the other big names in the US investment banking world saw bond trading profits dive in the three months to the end of June, save for age-old Goldman rival Morgan Stanley, which restricted the loss to 4%.
Lloyd Blankfein, the Goldman boss who rose through the ranks of bond traders to the top job, was unlikely to be sanguine about the turn of events amid concerns that his bank suffered more than most for relying on out-of-favour hedge funds as clients.
Back in October 2016 the story was very different. Barclays was on a high after what it said was a summer bonanza for its bond traders, pushing quarterly profits to a two-year high. Likewise Goldman, Deutsche Bank, Bank of America and JPMorgan were raking in the trades.
Much of the reason for their optimism was a change of stance at the Federal Reserve. The US central bank signalled in late 2015 that the post-crash era of low inflation and low interest rates was coming to an end. To combat the threat of inflation, it would start to raise rates consistently through 2016 and 2017.
This move put two trends in motion that spelled a big payday for the banks. First, the price of bonds started to fall, making them more attractive to buy. Second, not long afterwards, it became clear the other central banks were not going to follow suit in raising rates.
That broke seven years of agreement among the major central banks to hold interest rates at near zero as a way to boost economic activity. The Bank of England, the European Central Bank and the Bank of Japan were still on board, but Janet Yellen at the Fed had broken away.
Without a consistent story, investors in fixed-income securities, the jargon name for bonds, found themselves needing to back several horses. And investors demanded the banks buy and sell their securities more frequently as uncertainty translated into an ever-changing mood in the market.
The main measure of volatility – the Vix index – was still well below the 2009 peak, but it was elevated in 2016. And traders make money in periods when uncertainty and confusion raise levels of volatility.
Until this moment bond trading floors had undergone a dramatic cultural shift. The brazen antics of Oliver Stone’s flamboyant junk bond king character Gordon Gekko in his film Wall Street were consigned to history. In came the sober suits with an emphasis on cost control.
Jordan Hiscott, chief trader at trading firm Ayondo, said the bond markets have become a more sober environment since the financial crisis. Lower profit margins and clients from the pension fund industry and sovereign wealth funds focusing on costs have forced the industry’s colourful characters to tone down their antics.
“It might be that Goldman suffered more than most because its reputation is for charging high prime broking fees. A reliance on clients like hedge funds, which are clearly out of favour for charging high fees themselves, might also have hurt Goldman,” he said.
Dhaval Joshi, chief European investment strategist at BCA Research, said the bond boom had come to an end as the fog around the course of interest rates, made worse by Brexit and the election of Donald Trump, intensified.
“When the Federal Reserve signalled that it would begin to raise interest rates, it changed the story. Since then there hasn’t been a clear path,” he said.
Major bond investors got burned by this turn of events and while their initial reaction was to instruct the banks to switch their portfolios – prompting a rise in trading fees – they are now reluctant to take big bets.
Joshi says the long-run trend for low inflation and low interest rates is about to reassert itself. This might mean a few more fees for the bank’s bond departments as asset managers adjust their holdings again. But in the longer term, it means a loss of business as investors go back to just holding long-term positions.
“I don’t think the long term trend is about to reverse, mainly because I don’t believe inflation is about to return,” he says.
A realisation that Donald Trump’s promises of higher growth, and with it higher inflation, are unlikely to happen for several years, if at all, and that Brexit will also take years to happen, add to the sense of renewed calm, and lower profits for bond traders.
guardian.co.uk © Guardian News and Media Limited 2010