NEW YORK, Oct 15 Reuters : Wall Street banks have been among the biggest beneficiaries of the sub-prime trading boom, fueled by the federal reserve's massive injection into financial markets.
The central bank is nearing the time when it 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, analysts, investors and executives say.
The Fed has been buying government bonds since March 2020, adding $4 trillion to its current balance sheet, as part of an emergency response to the COVID- 19 pandemic.
The strategy was designed to stabilize and ensure that companies and other borrowers had adequate access to capital. It 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.
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 profits last year and the first three quarters 2021 compared with the comparative quarters in the year prior to COVID's statement.
The trading bonanza, along with a boom in broader deal making, has helped global stocks outperform the national market. The KBW Bank Index has increased by 40% year-to-date compared with a 19% advance in the S&P 500.
Now, banks with large trading businesses are expected to profit a second time as Fed begins to pull the stimulus, prompting investors to rejig their portfolios again.
As investors look for position based on this volatility, that creates an opportunity for us to make markets for them. And obviously that would lend itself to an improved performance, Citigroup Chief Financial Officer Mark Mason told reporters this week.
In September, Fed Chair Jerome Powell signaled that tapering would be imminent. An official announcement is expected in November and the Central Bank signaled it will look at halting asset purchases completely by mid-2022 - a timetable seen by some investors as aggressive.
Banks have already benefited from higher volatility since Powell's comments in late September, which led to a dip in Treasury yields and a drop in equity markets. That led to a recovery in trading volumes at the start of the third quarter and the end of the fourth 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 safe assets in favor of riskier havens, leading to a spike in government bond yields and sharp fall in equity markets.
Fed officials are confident of avoiding this scenario and giving markets sufficient 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, said JMP Securities analyst Devin Ryan.
Third-quarter results from the biggest U.S. banks this week showed strong performances in equity trading, boosted by stocks hitting record highs but a less optimistic performance in bond trading reflecting calm in those markets.
Investors are anticipating activity will ramp up again in the lead-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.