BAC Bank of America Corporation

By Ben Eisen 

Big U.S. banks have bemoaned low interest rates for years, but instruments linked to those rates have recently proven to be one of the few strong spots for their trading businesses.

Rates trading, which typically encompasses government bonds and derivatives, was up at J.P. Morgan Chase & Co., Bank of America Corp., and Citigroup Inc. during the first three months of the year. The rise is a bright spot in an otherwise declining category; major banks have seen a multiyear slide in revenue from trading fixed income, commodities, and currencies, which includes rates.

The rise reflects a jump in interest-rate volatility during the first quarter as investors grew worried about a global economic slowdown. A flurry of trading pushed the yield on the benchmark 10-year U.S. Treasury note down more than half a percentage point in January and February to as low as 1.64%.

The increase is also a sign of the new regime for trading as regulations make it more difficult for banks to hold bonds on their balance sheets, making them more reliant on facilitating trades for clients. That revenue is now more dependent on high volumes because traders can no longer harvest big gains from making their own large bets on the direction of interest rates, analysts say.

The banks don't break out revenue for rates trading. But last year's first quarter is an indicator of what performance could look like for the same period this year because they had similar volatility. Revenue from trading rates of G-10 countries jumped 17% that quarter from a year earlier, according to research firm Coalition, which compiles trading data from the largest banks. Interest-rate volatility climbed at the beginning of last year amid a series of European Central Bank stimulus measures.

Volatility in U.S. interest rates increases the revenue of stateside banks the most, according to George Kuznetsov, head of research and analysis at Coalition. Chicago Board Options Exchange's index of 10-year Treasury volatility climbed by more than 50% between the end of December and its recent peak on Feb 11.

"For those banks particularly, the U.S. market is a very important market where they tend to be better," Mr. Kuznetsov said. "U.S. banks tend to be strong in the U.S. rates market compared to international."

Citigroup on Friday cited "growth in rates [and] currencies," despite an 11% quarterly drop in debt trading over the previous year.

Bank of America said Thursday that sales and trading revenue in its fixed income, currencies and commodities group dropped 17% in the latest quarter from a year earlier due partly to low interest rates. But the "weak trading environment" for credit products and foreign exchange was "partially offset by improved performance in rates and client financing."

J.P. Morgan said Wednesday that its fixed-income markets revenue was down 13% in first three months of the year from the same quarter in 2015, but it would have been worse if not for "an increase in the Rates business."

Morgan Stanley is set to release earnings on Monday and Goldman Sachs Group Inc. on Tuesday.

It has become more difficult for banks to hold large amounts of debt on their balance sheets, raising concerns about whether it has become more difficult to transact in the deepest government-bond market in the world. That became a prominent concern on Wall Street, particularly after a "flash crash" in U.S. Treasury yields in October 2014.

But the market for U.S. Treasurys is changing. Constrained balance sheets are pushing banks to hold fewer bonds and instead act as facilitators of big trades, according to Kevin McPartland, head of market structure and technology at Greenwich Associates.

In that environment, making money in rates trading is more about volume than making big directional bets on the path of interest rates. The burst of trading that pushed up interest-rate volatility provided much of that volume, he said.

"There's a huge cyclical component here," Mr. McPartland said. "If the markets come back to life a bit, that should buffer the impact of the regulatory changes that hurt these businesses."

(END) Dow Jones Newswires

April 18, 2016 05:44 ET (09:44 GMT)

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