Wall Street banks step up preparations for Fed tapering volatility
02/11/2021 13:23
By Matt Scuffham
NEW YORK, Nov 2 (Reuters) - Wall Street banks are
intensifying preparations for the Federal Reserve's withdrawal
of pandemic stimulus to ensure they are able to handle spikes in
market volatility, help clients manage their risks -- and score
a profit.
With the Fed expected to formally announce on Wednesday that
it will begin tapering its monthly bond purchases, sales and
trading teams are hearing more from clients concerned about the
ramifications for their portfolios and the longer-term
implications of rising rates and higher inflation, several
senior bankers said.
"This is the most important issue on their minds. People
have to revamp their portfolios and hedge their risk," said the
head of fixed income, currencies and commodities (FICC) trading
at one large global bank, speaking on the condition of
anonymity.
The expected increase in volatility presents an opportunity
for trading desks to profit by helping clients buy and sell
securities, provided the spread between bids and offers doesn't
become so stretched that it is impossible to make a market - a
scenario bankers say is unlikely because the Fed has given
plenty of warning of its intentions.
Nevertheless, in recent weeks banks have been running
simulations to ensure their systems can handle spikes in
volatility similar to 2013's 'taper tantrum https://www.reuters.com/article/us-usa-fed-2013-timeline/key-events-for-the-fed-in-2013-the-year-of-the-taper-tantrum-idUSKCN1P52A8,
' when a similar but unexpected decision by the Fed sent markets
into a frenzy, and to prepare for different market scenarios,
according to three trading sources.
"No one wants to see dislocated markets. If that happens
it's bad for clients and for the industry because volumes
effectively dry up," one of the sources said.
While such contingency planning is not unusual around major
events, it underscores the depth of concern on Wall Street about
how markets will react when the Fed stops pumping liquidity
into capital markets.
The U.S. Treasuries market is already experiencing liquidity
challenges which could spill into other markets, Bank of America
warned in a report on Monday. urn:newsml:reuters.com:*:nL1N2RS1N2
The central bank has been buying up government-backed bonds
since March 2020, adding $4 trillion to its balance sheet, as
part of an emergency response to the COVID-19 pandemic.
The strategy was designed to stabilize financial markets and
ensure companies and other borrowers had sufficient 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 and leading
to record levels of acquisitions and stock market listings.
Senior bankers are now grappling with how markets will react
when that stimulus is taken off the table and what that means
for their institutions.
"Tapering by the Fed certainly has the potential to remove
some of the 'frothiness' from the market," said Paul Colone,
U.S.-based managing partner at Alantra, a global mid-market
investment bank.
2013 REDUX?
Most bankers, however, do not expect a repeat of 2013, when
the Fed began withdrawing stimulus it had introduced as a result
of the 2007-2009 global financial crisis.
Back then, volatility spiked as investors tried to get ahead
of the Fed by dumping bonds, leading to a surge in government
bond yields, and moved out of riskier assets like stocks.
This time, there should be enough volatility to boost
trading volumes but not disrupt investment banking pipelines,
bankers say. The process could actually encourage deal-making if
it eases inflation and supply chain concerns.
"If tapering relieves some of the pressure of rising prices
then that has the potential to benefit many businesses," said
Colone.
Investors are looking at creative ways to profit from the
volatility created by tapering and uncertainty over how quickly
interest rate hikes will follow, according to several market
participants.
"Smart traders on Wall Street use a lot of leverage to take
advantage of these tensions or mis-pricings, said Matt Freund,
co-chief investment officer at Calamos Investments.
Investors are piling into relative value trades, betting on
whether tapering and future rate hikes by the Fed and other
central banks will affect government bond yields more in some
countries than others, one FICC trader said.
Others are studying the market reaction to the 2013 tapering
to inform their strategies.
"The market always learns and adjusts," said Freund. "2013
is a lesson that's not going to be ignored."
(Reporting by Matt Scuffham; Editing by Michelle Price and
Andrea Ricci)
((matthew.scuffham@thomsonreuters.com; +1-332-201-0609; Reuters
Messaging: matthew.scuffham.reuters.com@reuters.net))