The pandemic-era trading boom, fueled by the Federal Reserve’s massive injection of cash into financial markets, has seen Wall Street banks being among the biggest beneficiaries.
Analysts, investors, and executives say that as it nears the time when the central bank will start winding down its asset purchases, banks are set to profit again as increased volatility encourages clients to buy and sell more stocks and bonds.
Since March 2021, as part of an emergency response to the COVID-19 pandemic, the Fed has been buying up government-backed bonds, adding $4 trillion to its balance sheet.
The strategy, designed to stabilize financial markets and ensure companies and other borrowers had sufficient access to capital, succeeded but also resulted in unprecedented levels of liquidity, helping equity and bond traders enjoy their most profitable period since the 2007-09 financial crisis.
According to company earnings statements, an additional $51 billion in trading revenues was made by the top five Wall Street investment banks – JP Morgan Chase & Co (JPM.N), Goldman Sachs (GS.N), Bank of America (BAC.N), Morgan Stanley (MS.N) and Citigroup (C.N) – last year and in the first three quarters of 2021, compared with the comparative quarters in the year before COVID.
In addition to a trading bonanza, a boom in global deal-making has also helped bank stocks outperform the broader market. The KBW Bank index (.BKX) has risen by 40% in the year-to-date compared with a 19% growth in the S&P 500 (.SPX).
As the Fed starts to withdraw the stimulus, banks with large trading businesses are now expected to profit a second time prompting investors to rejig their portfolios again. Citigroup Chief Financial Officer Mark Mason told reporters this week:
“As investors look to position based on that volatility that creates an opportunity for us to make markets for them. And obviously, that would lend itself to improved performance.”
In late September, Fed Chair Jerome Powell signaled that tapering was imminent. An official announcement is expected in November and by mid-2022 the central bank has signaled that it will look to eliminate asset purchases completely – a timetable seen by some investors as aggressive.
Since Powell’s comments in late September, which led to a spike in Treasury yields and a decline in equity markets, banks have already benefited from enhanced volatility. Executives say it led to a pick-up in trading volumes at the end of the third quarter and the start of the fourth quarter.
Morgan Stanley Chief Financial Officer Sharon Yeshaya said on October 14:
“It is possible we will see bouts of volatility associated with the tapering.”
She also said that she does not expect a repeat of 2013’s ‘taper tantrum.’ The Fed’s decision to put the brakes on a quantitative easing program, at that time, sent markets into a frenzy as investors dumped riskier assets in favor of ‘safe havens,’ leading to a spike in government bond yields and sharp falls in equity markets.
By giving markets enough warning of their intentions, Fed officials are confident of avoiding that scenario this time around. JMP Securities analyst Devin Ryan explained:
“The sweet spot is where you have some volatility but not enough to disrupt the broader capital markets which have been an important contributor to healthy trading results over the past year.”
This week, the third-quarter results from the biggest U.S. banks showed strong performances in equities trading, boosted by stocks hitting record highs, but a more subdued showing in bond trading reflecting a calm atmosphere in those markets.
When the run-up to tapering eventually begins, investors are anticipating activity will ramp up again.
“It will certainly be a positive,” said Patrick Kaser at Brandywine Global Investment Management. “Volatility is a friend to trading businesses.”