By Jamie McGeever
LONDON (Reuters) - Recent stirrings of long-dormant financial market volatility have come in the nick of time for an industry that has been bleeding revenue and jobs for years, even though bankers doubt the secular downsizing of the trading world can be reversed.
The prospect of higher U.S. interest rates, and to a lesser extent interest rates, has provided a shot in the arm for market activity and banks' trading operations since the half year mark.
Trading in fixed income, currencies and commodities (FICC) has been steadily falling since the 2008 crisis, in large part thanks to a collapse and convergence of interest rates across the developed world that has crushed volatility.
Key measures of price volatility - particularly in currencies, which in large part trade on interest rate differentials - have sunk this year.
Implied volatility in euro/dollar and dollar/yen, the two most liquid currency pairs in the world, fell to a record low in July. U.S. stock market volatility hit a 7-year low and bond volatility languished near recent depths.
Low volatility limits price swings and narrows bid/offer spreads, thereby minimizing banks' scope to make money. Post-crisis regulation such as 'Dodd-Frank' and 'Volcker Rule' legislation in the United States and Basel III banking reforms globally also effectively restrict banks' ability to hold, trade and speculate on fixed income and derivatives.
But volatility has since reversed, lifted by U.S. rate speculation and a range of geopolitical flare-ups that caught markets offguard. Treasury bond and FX market volatility rose to levels not seen since January.
"Fixed income does show like it's showing a few signs of life. But we're not out of the woods," said Chris Wheeler, banking analyst at Mediobanca in London.
So far this year, the trading environment has been tough for banks' FICC operations, which critics sometimes dub "casino banking" and distinguish from traditional investment services like underwriting share issues or arranging mergers and acquisitions.
Reuters data show that of 10 major U.S. and European investment banks, only Morgan Stanley and Bank of America-Merrill Lynch raked in higher FICC trading revenue in the first half of this year compared with the same period last year.
The other eight saw revenues fall, from Credit Suisse and Societe Generale's 6 percent decline to the 23 percent slump at Barclays. The average decline across the 10 banks was 10 percent.
http://graphics.thomsonreuters.com/14/02/BANK_IBREVENUE0214_VF.html
WHEN THE TREND ISN'T YOUR FRIEND
Major U.S. and European banks will report third-quarter earnings results from next month. That quarter is usually weak because it covers the summer months of July and August, leaving September to make up the shortfall.
Credit ratings agency Standard & Poor's argues that while FICC trading will recover "eventually", revenues will probably still be between 5 and 10 percent lower this year than last.
But there are encouraging signs as the Fed prepares the ground for what will be its first rate hike since June 2006, with the Bank of England to follow a similar path.
Yields on benchmark 10-year U.S. Treasuries have risen more than 20 basis points so far in September, on track for the biggest monthly rise this year.
And speculators last week amassed a net short position in two-year Treasury futures on the Chicago futures exchanges worth 98,610 contracts, the biggest bet in over seven years that shorter-term U.S. bond yields will rise.
"If you're big in foreign exchange and big in U.S. rates, you will start to see things pick up throughout the rest of the year," said Simon Maughan, product specialist at financial-data supplier OTAS Technologies.
But the drive to cut costs across the industry shows little sign of easing. Banks are laying off thousands of staff, notably the thousands of job losses announced by Barclays in May.
In a report published earlier this month, London-based consulting firm Coalition said the reduction in global FICC staff during the first half of the year was far bigger than that seen in banks' equities or investment banking divisions.
Headcount fell 9 percent to around 17,700 from 19,600 in the same period last year, compared with a two percent fall in equities and a one percent fall in investment banking. Since the first half of 2011, FICC staffing has shrunk by more than a quarter, Coalition said.
The division that has seen the biggest slump in revenue so far this year, according to Coalition, is G10 foreign exchange trading, down 35 percent to $2.7 billion. And in the last two years, G10 rates trading revenue has almost halved to $9.8 billion.
"Costs will continue to be cut, and the challenges on costs will remain," said the head of rates trading at a bank in London. "It's premature to envisage a pick up in hiring."
And pay for those lucky enough to hold onto their jobs isn't rising much, if at all. Options Group, a consultancy, predicts that average compensation in rates trading will fall this year by 15 to 20 percent from last year.
(Reporting by Jamie McGeever, editing by Louise Heavens)
