| NEW YORK
NEW YORK Wall Street banks have had another rough quarter in bond trading thanks to the U.S. Federal Reserve, and it might get worse before it gets better.
Analysts have begun cutting third-quarter profit estimates for banks including Goldman Sachs Group Inc (GS.N) and Morgan Stanley (MS.N), citing an industry-wide fixed-income trading revenue decline of 20 to 30 percent compared with a year ago. The quarter's lull has made at least some Wall Street professionals nervous that a fresh round of job cuts may be coming, a trader said.
The third quarter is typically a weak period for banks' trading businesses, but the Fed's decision to keep its program of bond buying intact has hurt trading revenue even more than usual and weighed on the value of the bonds that dealers keep on hand for trading, bankers and analysts said.
Traders in some of the biggest fixed-income markets - including Treasury bonds, mortgage bonds, interest-rate derivatives and foreign exchange - were burned by their wrong assumptions about when the Fed would pull back from its massive bond-buying program. Many investors had expected the Fed to start gradually winding down the program, but instead the central bank in its September 18 policy statement said that it would maintain its $85 billion monthly purchases for the time being.
The decision led investors to hit the brakes on plans to adjust their portfolios, traders and analysts said, and less activity meant less money for banks' fixed-income trading desks.
"From what I can see, it's mainly weaker activity levels - activity levels are just very low," said Richard Ramsden, an analyst who covers banks for Goldman Sachs.
There are already signs of poor third-quarter results.
The investment bank Jefferies Group LLC said earlier this month that its fixed-income trading revenue plunged 88 percent in the three months ended August 31, to $33 million from $266 million a year earlier. Jefferies is not directly comparable to bigger Wall Street banks because of its size and because it reports on a fiscal calendar whose quarters are a month earlier, but the results were still surprisingly poor.
Last week, Deutsche Bank AG (DBKGn.DE) co-CEO Anshu Jain said at a conference that he expected bond-trading revenue would "decline significantly" in the third quarter due to weak volumes. Bank executives from JPMorgan Chase & Co (JPM.N), Morgan Stanley and Barclays PLC (BARC.L) have also recently warned in public comments that they expected trading revenues to be soft.
JPMorgan, which is scheduled to post third-quarter results on October 11, will be the first big Wall Street bank to report. The largest U.S. bank is expected to earn $1.27 per share, compared with $1.40 per share for the same quarter last year, according to estimates compiled by Thomson Reuters I/B/E/S.
Morgan Stanley posts results on October 18 and is expected to earn $0.48 per share compared with a loss of $0.55 per share in the third quarter of 2012. Goldman Sachs will report its third-quarter earnings on October 17 and is expected to earn $2.61 per share compared with $2.85 a year ago.
Trading aside, there were few bright spots in other capital markets businesses.
Debt underwriting revenue is expected to have fallen 26 percent compared with the third quarter of 2012, according to Bernstein analyst Brad Hintz. The decline comes despite some large bond offerings, such as Verizon Communications Inc's (VZ.N) $49 billion capital raise earlier this month, and strong leveraged loan activity. Hintz expects equity underwriting revenue to have dropped 27 percent.
Dealmaking fees are also expected to be soft, even with Verizon's blockbuster $130 billion purchase of Vodafone Group's (VOD.L) share of its wireless business. Hintz estimates Wall Street banks will report flat merger and acquisition revenue.
So far this year, global deal volume is up just 0.8 percent compared with a year ago, to $1.67 trillion, according to Thomson Reuters data. Excluding the Verizon-Vodafone deal, global deal volume fell 7 percent to $1.54 trillion.
"Although the Verizon deal and a flurry of September M&A announcements is encouraging, these deals will not be enough to save the quarter," said Hintz.
GRAND FUNK LIVES
Although trading revenue is by its nature a volatile line item, it has become even harder for analysts to predict since the financial crisis, said Oppenheimer analyst Chris Kotowski. Three years ago, he expected trading revenue would have stabilized by now - especially as the industry consolidated - but instead it "looks more like a Ping-Pong ball bouncing down the stairs" than any kind of decipherable trend line, he said. If trading revenue has dropped in the third quarter, it will be the 10th decline in the last 14 quarters, he said.
"The funk is not over," Kotowski said.
Wall Street trading desks do not expect an upswing in fixed-income revenue before the Fed's December policy meeting, said one bond trader who spoke on the condition of anonymity. The industry has been in decline since the financial crisis, as new capital rules have prodded banks to sell or unwind some of their riskiest assets. Also, derivatives trades that once happened among banks are moving onto exchanges and into clearinghouses, which weighs on profit margins.
With these changes afoot, banks since 2010 have been slashing thousands of trading, sales and support jobs.
Beyond the secular pressure on the sector, markets were rattled in May when Fed Chairman Ben Bernanke hinted that tapering would come soon. Long-term interest rates spiked in late May and continued rising until the Fed's latest announcement. The 10-year Treasury yield ended the quarter around 2.61 percent, compared to around 2.477 percent at the beginning of the quarter. But between those relatively similar values were some wild gyrations — the yield reached as high as 3 percent during the quarter.
"The Fed, through its communications, has caused some uncertainty," said Goldman's Ramsden. "The message has changed and people have gotten wrong-sided, so until people get comfortable with what the new world looks like and what the path looks like, it could keep impacting activity. When will that happen? Hard to say."
Because fixed-income trading accounts for a big chunk of overall income at Wall Street banks, market disruptions can put a serious dent in profits. Interest-rate sensitive products like Treasury bonds and foreign-exchange represent 40 to 50 percent of fixed-income trading revenue, Ramsden said, making it difficult for banks to make up for weak trading there with other businesses that performed well, like high-yield debt trading.
(This story has been corrected to show that Morgan Stanley will report earnings on Oct. 18, not on Oct. 14, in the 11th paragraph)
(Reporting by Lauren Tara LaCapra, additional reporting by Peter Rudegeair; Editing by Leslie Adler)