U.S. banks expected to profit again as Fed cuts asset purchases

NEW YORK, Oct 15 Reuters - Wall Street banks have been among the biggest beneficiaries of the pandemic trading boom fueled by the Federal Reserve's massive injection of cash into financial markets.

Upon the time when it will start to stop its asset purchases, banks are set to profit again as increased volatility encourages clients to buy and sell more stocks and bonds, analysts, investors and executives say.

Since March 2020, the Fed has been buying government-backed bonds and adding 'increased' $4 trillion to its balance sheet, as part of an emergency response to the COVID virus emergencies.

The strategy was designed to stabilize financial markets and ensure borrowers and other borrowers had adequate access to capital. It was profitable but also resulted in unprecedented levels of liquidity helping equity and bond traders enjoy their most profitable period since the 2007 - 09 financial crisis.

The top five Wall Street investment banks - JP Morgan Chase Co, Goldman Sachs, Bank of America, Morgan Stanley and Citigroup - made an additional $51 billion in trading revenues last year and in the first three quarters of 2021 compared with comparative quarters in the year before COVID.

The trading bonanza, along with a boom in global deal-making, has helped bank stocks outperform the broader market. The S&P 500 index climbed in the year-to-date by 40% compared with a 19% advance in KBW Bank index.

Now, banks with large trading businesses are expected to profit a second time as the Fed begins to withdraw the stimulus, prompting investors to rejig their portfolios again.

As investors look to make a market for them based on this volatility, that creates an opportunity for us to make markets for them. Of course, that would lend itself to more performance, Mark Mason told reporters this week - Chief Financial Officer (Citizengroup).

In September, Fed Chair Jerome Powell signaled that tapering was imminent. An official announcement is expected in November and the central bank has signaled it will look to demonetize asset purchases by mid-2022 - a timetable seen as aggressive by some investors.

Banks have already benefited from enhanced volatility since Powell's comments in late September, which led to a decrease in Treasury yields and a drop in equity markets. That led to a pick up in trading volumes at the end of the fourth quarter and during the beginning of third quarter, executives say.

At that time, the Fed's decision to put the brakes on a quantitative easing program 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.

Fed officials are confident of avoiding that scenario this time around by giving the markets enough advance warning about their intentions.

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, added JMP Securities analyst Devin Ryan.

Third-quarter results from the biggest U.S. banks this week showed subdued performances in stock trading, boosted by stocks hitting record highs but a stronger performance in bond trading reflecting calm in those markets.

Investors are anticipating activity will ramp up again in the run-up to tapering, when it eventually begins.

It will certainly be a positive, said Patrick Kaser of Brandywine Global Investment Management. Volatility is a friend to trading businesses.