With FICC Woes Behind Them, Banks Ready To Benefit From Interest Rate Volatility

With bank revenues coming out of their fixed income, currencies and commodities (FICC) trading knuckle-dragging to shockingly low levels, and dulcet volatility putting traders at institutional desks to sleep, there could be hope around the corner for the banks. But with the US Federal Reserve expected to raise interest rates nearly 75 basis in 2018, interest rate volatility, the friend of bank trading platform, might return. If this happens, three banks could clearly shine.

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Revenue Multiples
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Bank FICC revenues have suffered recently

When Goldman Sachs reported fourth-quarter earnings of $5.68 a share, it beat Wall Street estimates. Revenue, reported at $7.83 billion, was higher than estimates of $7.61 billion as mergers and acquisitions was a steady mainstay that has eclipsed its traditional bailiwick of fixed income trading.

And it is here that the earnings announcement, while generally positive, had a negative tone.

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FICC revenues plunged 50% on a year-over-year basis, as overall trading revenue was off by 34%.

As if to punctuate the importance of FICC revenue, Goldman’s stock fell more than 2% after the announcement, but have since recovered.

"That FICC trading number was shocking," Gerard Cassidy, managing director at RBC Capital Markets, told CNBC. "Their FICC trading numbers are so much weaker than their competitors."

Goldman isn’t the only large bank suffering from dormant volatility.

The five largest banks saw their FICC trading revenue fall below $11 billion in the third quarter of 2017, falling under low levels not seen since the fourth quarter of 2015. During that third quarter, JPMorgan FICC trading revenue was down 27%, with Goldman off 26.1% and Morgan Stanley off by 21.1%. Citigroup, known for its interest rate platform, was down 17%.

While the recent past has been a challenging, that could be about to change.

Get ready for a FICC trading revenue turnaround if interest rate volatility comes back

Tax reform is expected to provide strong tailwinds for the banks, with Oppenheimer’s Chris Kotowski calling it “gravy.”

“The tax law will, of course, mainly be ‘gravy’ for the banks in that their near-term after-tax net income should rise significantly,” he wrote in a note earlier this month reported by Yahoo Finance.

While tax reform is expected to boost bank earnings, so too might FICC trading revenues.

“Banks both large and small are preparing to capitalize on any favorable changes to the business environment,” says Greenwich Associates Managing Director Frank Feenstra said in a statement.

In a report out January 25, Greenwich observes that banks are expecting volatility to return and generate trading revenue.

“Banks around the world are upgrading—or at the very least, maintaining—their fixed-income platforms to take full advantage when volatility returns and client trading activity and revenues grow as a result,” the report stated. “However, recent action by the U.S. Federal Reserve has banks hoping that a long-awaited turn in the interest-rate cycle has begun and that a pickup in volatility and trading volume could be on the horizon.”

If trading revenue picks up, there could be clearly differentiated winners seen through the bank trading platforms.

The largest and highest-rated of the platforms belong to Citi and J.P. Morgan, a Greenwich study noted. Citi pulled in the top ranking for the third consecutive year in terms of global fixed-income market share, with J.P. Morgan placing second and Goldman Sachs holding onto the third spot.

“Among this group of leaders, Citi and J.P. Morgan stand apart, not just for their dominant market shares, but also for the quality of service they deliver to fixed-income clients around the world,” Greenwich noted, with strong mention going to Barclays and Goldman Sachs.

As interest rates rise, good tidings for the banks could come in many forms.

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Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)valuewalk.com