Wall Street’s Biggest Business Braces for Lackluster Third-Quarter Results
The volatility that has boosted banks’ stock-trading business is hampering their fixed-income, commodities and currencies desks
The same volatility that has boosted banks’ stock-trading business is hampering their fixed-income, commodities and currencies desks, setting Wall Street up for another tepid quarter.
The two biggest U.S. trading banks, JPMorgan Chase JPM -1.47% & Co. and Citigroup Inc., C -1.66% expect to report lukewarm results in their markets businesses for the third quarter. JPMorgan said this summer it anticipated a small decline from the year-ago period, while Citigroup said it might record a small uptick.
The threat of a trade war and increasing uncertainty about the inflation outlook have roiled stocks at times this year, giving a lift to traders dealing in stocks and derivatives tied to volatility. Yet the uncertainty has crimped some corporate activity, such as cross-border investment and debt issuance—major drivers of trading in interest rates, currencies and bonds.
Analysts expect that strong performances in stock-trading units will be erased by declines elsewhere. Susan Roth Katzke, an analyst at Credit Suisse Group AG, forecasts that fixed-income trading will log a year-over-year revenue decline of around 5% to 10% for the third quarter, even as equities revenue rises by as much as 5%.
Wall Street’s fixed-income, currencies, and commodities businesses are still a shadow of what they were before the financial crisis. In 2009, the dozen biggest banks globally generated some $140 billion in revenue from those desks, versus less than $70 billion last year, according to industry data tracker Coalition.
Until this year, revenues stemming from interest-rates and currencies trading had been a rare bright spot, rising from a low point in 2014. Banks have sought to reorient the business around corporate customers, which provide a steady stream of activity related to financing and trade.
Through the first half of this year, revenues in rates and foreign-exchange trading for U.S. banks fell 12% from 2017, according to figures from the Office of the Comptroller of the Currency. Rates and currencies make up more than 40% of banks’ total trading revenue.
By contrast, stock-trading desks at big banks have been enjoying their best year in a decade. Across all banks, stock-trading revenue is up 21% so far this year, according to the OCC.
Wall Street doesn’t appear ready to bet that the slowdown in rates and currencies trading will be an extended lull, as it was for years with stocks.
While the Federal Reserve said it expects to raise rates one more time this year, uncertainty over the longer-term outlook could drive trading activity. Additionally, a slowdown in central banks’ buying of government bonds and an increase in U.S. debt issuance could spur bank clients to step up their purchasing of Treasurys and related derivatives.
Banks also are hesitant to scale back any services they provide to corporate clients of their trading desks, who can supply lucrative business to their investment and commercial banks.
“Banks are committed to the [trading] business because their clients are committed to the business,” Credit Suisse’s Ms. Katzke.
Assets on the balances sheets of the five biggest trading banks —JPMorgan, Citigroup, Bank of America Corp. BAC -1.60% , Goldman Sachs Group Inc. GS -1.54% and Morgan Stanley MS -2.51% —related to the rates business at the end of June collectively stood at their highest level since the first quarter of 2014, according to figures compiled by Credit Suisse.
Another key measure, the value of derivative contracts held by U.S. banks tied to interest rates, also was up 13% from a year ago as of the end of the second quarter, according to the OCC.
“For the U.S. banks, we are back in an investment phase in the [trading] business, with the belief that these businesses have passed their trough,” Ms. Katzke said.
A big risk, however, is that an unexpected change in inflation expectations or in forecasts of central banks’ behavior could spark a rush to exit investments tied to rates, including U.S. Treasurys.
In that case, banks may find themselves exposed, according to Moody’s Corp. A disorderly sale of Treasurys or a hiccup in global growth could impact banks’ revenues through “market or credit losses and reduced client activity,” the ratings firm said in a recent report.