June 5, 2017 / 10:56 AM / 5 months ago

COLUMN-Trading blues? It's just another kick in the vol: McGeever

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Jamie McGeever

LONDON, June 5 (Reuters) - Executives at some of the world’s biggest banks are warning that challenging market conditions could lead to a fall in second quarter trading revenues, with much of the blame being laid at a familiar door: low volatility.

JP Morgan chief financial officer Marianne Lake, Bank of America chief executive Brian Moynihan and Morgan Stanley CEO James Gorman all said last week that Q2 trading revenue is on course to fall by 10-15 percent.

Banks generally find it harder to make money when volatility is low because it lessens their ability to take advantage of big price swings, so it’s often a valid, if convenient, explanation.

The trouble is, it doesn’t fully bear scrutiny.

There are several reasons why volatility across many markets is at its lowest in years and in some cases, decades.

Among them are structural shifts following last decade’s global financial crisis, such as healthier bank balance sheets, lower leverage, tighter regulation and oceans of central bank liquidity that have compressed yields, returns and spreads.

Other factors steady-if-unspectacular global growth, and more sophisticated hedging strategies whereby investors minimize their exposure to volatility by simultaneously buying and selling options.

And there are several well-documented reasons behind the erosion of banks’ trading income over the same period -- automation, tighter spreads, increased regulation limiting their trading activities, and, yes, low volatility.

But revenue can rise when volatility falls, and vice versa, which raises the question of whether weak trading performance is too easily blamed on “bad” volatility.

THE FICC OF IT

In the first quarter of this year, revenues from fixed income, currency and commodity (FICC) trading at the world’s top 12 banks rose 19 percent, to $21.4 billion from $17.9 billion a year earlier, according to industry analysis firm Coalition.

That was despite a widespread fall in volatility. One-month implied volatility in U.S. Treasuries averaged 68 percent in Q1 , down from 75 percent in the same period last year, while average one-month implied euro/dollar volatility fell to 8.9 percent from 9.7 percent.

The comparison between the April-June quarters of 2014 and 2015 shows the opposite phenomenon.

Average one-month implied Treasury volatility in Q2 2014 was a post-crisis low of 58 percent, jumping to an average 85 percent a year later. Similarly, one-month implied euro/dollar volatility averaged just 5.5 percent in Q2 2014 only to more than double to 12.7 percent in Q2 2015.

Yet FICC revenues at the top 12 banks tracked by Coalition fell 12 percent in Q2 2015 from a year earlier, to $16.1 billion from $18.2 billion.

The current quarter has been marked by remarkably low headline volatility. But despite last week’s warnings from U.S. bank executives, it’s hardly lacked trading opportunities or big shifts in market positioning.

The month of May saw speculators on the Chicago futures markets increase their long positions by a net 85,000 contracts -- the second-biggest monthly change to going long euros since the single currency’s inception in 1999.

In early March, speculators held a record net short position in 10-year Treasuries to the tune of 409,000 contracts. They are now net long 362,500 contracts, the highest in almost a decade and reflecting a remarkable turnaround in barely three months.

And while one-month implied volatility in equities, bonds and currencies is stubbornly low, implied volatility several months out has fallen nowhere near as much. There is volatility out there, it’s just further out the curve.

Perhaps the link between low volatility and sluggish trading isn’t as strong as many analysts -- and bank executives -- would have you believe.

Editing by Catherine Evans

Our Standards:The Thomson Reuters Trust Principles.
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