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Weak Bond Trading to Weigh Heavily on Banks

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With the U.S. banking sector still being challenged by tighter regulations, asset-quality troubles, mortgage liabilities and run-ins with the government regulators, top-line impediments continue to plague the participants. Additionally, a rough quarter in bond trading makes the scenario even worse.

Historically, the third quarter has witnessed weak trading operations. This was compounded by the Federal Reserve’s pronouncement to continue its bond buying activity.  

Traders in the treasury bonds, mortgage bonds, interest-rate derivatives and foreign exchange markets suffered a setback when the Fed announced that it would continue its colossal bond-buying program.  Experts had expected the Fed to gradually wind up the program. But they were in for a rude shock when in its Sep 18 policy statement, the U.S. central bank announced the continuation of its $85 billion monthly purchases for the near future.

The setback considerably affected the bond market, with lesser activity reducing banks' fixed-income revenues. We wonder whether this is a sign for tougher times to come.

The fact that Jefferies Group LLC’s fixed-income trading revenues fell 88% year over year to $33 million for the three months ended Aug 31, bears testimony to the fact that investment banking companies have been hit hard by the Fed’s decision. Even though Jeffries Group cannot be compared to Wall Street giants like The Goldman Sachs Group, Inc. (GS - Free Report) and Morgan Stanley (MS - Free Report) , the impact is to be taken note of.

Additionally, global banking giants like Deutsche Bank AG (DB - Free Report) , Morgan Stanley and Barclays PLC (BCS - Free Report) expect their trading revenues to decline primarily due to decreased trading activity.

Other capital markets businesses also did not have much to cheer about. Large bond offerings by companies like Verizon Communications Inc. (VZ - Free Report) and Apple Inc. (AAPL - Free Report) could do little to halt the sliding underwriting revenues. Moreover, the series of mergers and acquisitions in the recent past have failed to substantially raise expectations of revenues from deals.

Analysts have always found trading revenues to be too volatile to predict. Additionally, the financial crisis has made any possible forecast more difficult. With the global markets normalizing, trading revenues were expected to stabilize. However, this has not happened.

The U.S. fixed income market does not expect trading revenues to rebound before the Fed's policy meeting scheduled in December. Added to this, the stringent regulatory environment has forced banks to shed risky assets. Further, the derivative trade has become less profitable with the involvement of exchanges and clearinghouses. This has been a significant overhang to profitability.  

With the low interest rate environment still affecting the top line of major banks, fixed-income trading revenues were expected to counter the headwind. However, lower trading in the market can be a dampener to bank profits. With the Wall Street banks’ third-quarter results scheduled to begin with Wells Fargo & Company (WFC - Free Report) and JPMorgan Chase & Co. (JPM - Free Report) , the top line will be an area of scrutiny.

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