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A strong quarter does not mean fixed income is fixed

FX and macro volatility is back in a big way, so the succession of miserable quarters in fixed income, currencies and commodities should be over. But investment banks have not fixed long running problems with the business.

A quarter where the world’s central banks started pulling in opposite directions in earnest ought to be a good quarter for FX. New euros pumped into the system at €60bn a month, a new world of widespread negative rates and a US economy that looks stronger than ever means, at the very least, that clients should want to trade.

The Swiss National Bank’s abandonment of its currency peg blew a hole in a few balance sheets — Citi lost more than $150m, while Deutsche Bank and Barclays are also expected to book substantial losses — but industry-wide the shift should be roughly neutral (JP Morgan supposedly made $300m on its Swiss franc hedges).

But one thing the move did create was more trading opportunities after the fact, and far more volume in Sfr/euro than while the peg operated.

Rates trading has similarly had a hectic quarter. European government bonds screamed in after the European Central Bank's announcement of quantitative easing in January, to sag slightly ahead of the scheme's start. But with UK and US economies strengthening, and European yield curves stretching into negative territory, rates investors have had plenty of opportunity take a view (and plenty of capital appreciation in Europe).

The figures bear this out. JP Morgan investment banking analysts see G7 FX volatility and rates volatility up 30% on the year, and ICAP’s electronic FX average daily volume up 29%. Quarterly average daily volume in investment grade, recorded by FINRA, is up 25%.

In short, FICC divisions, the largest revenue engines in most investment banks, are revving again. Q1 is typically the strongest quarter (last year it was 31% of clean fixed income revenue, according to JP Morgan).

But it’s hard to see this as more than a blip in a structural decline. A world of leverage ratios guarantees that trading formerly risk-free instruments like currencies or government bonds becomes more expensive.

Add in swap clearing, the fundamental review of trading book capital and capitalising counterparty risk and the business looks vastly less profitable for the capital it is allocated.

Research firm Coalition said revenues declined every year after the crisis except 2012. The top 10 banks booked $141.6bn in FICC revenue in 2009, $98.5bn in 2010, but only $69.4bn in 2014.

That does not mean FICC should be written off. More bonds are being issued than ever before, investors still want to trade and take views, and the harder it is to match positions, in theory, the more important an intermediary with quality distribution and good market intelligence.

The trouble is, adjusting to this world will continue to be painful, and revenues will spread over different market players. Swap trading venues, electronic markets, and the buyside all want a slice of FICC trading economics, and that means less for the big dealers, even without the constraints of regulation.

Banks are starting to fight back, picking what they hope will be winners in e-trading, automating their systems — and brutally cutting costs in their fixed income teams. A strong first quarter will soften the blow, but the adjustment process has a long way to go.

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