NEW YORK (Reuters) – Wall Street banks are stepping up preparations for the Federal Reserve’s withdrawal of pandemic stimulus measures to ensure they are able to handle spikes in market volatility, help clients manage risk – and make a profit.
While the Fed is expected to officially announce on Wednesday that it will begin cutting back on 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 prices. rate and inflation, several executives told the bankers.
“This is the most important question they think about. People need to reorganize their portfolios and hedge their risks,” said the head of fixed income, currencies and commodities or FICC operations at a major world bank, s ‘expressing on condition of anonymity.
The expected increase in volatility presents an opportunity for trading desks to profit by helping clients buy and sell securities, provided that the spread between bids and bids does not become as wide as it is. impossible to create a market – a scenario according to the bankers is unlikely as the Fed has given numerous warnings about its intentions.
Nonetheless, in recent weeks, banks have run simulations to make sure their systems can handle spikes in volatility similar to the 2013 âtantrumâ, when a similar but unexpected move by the Fed plunged markets. into a frenzy, and to prepare for different market scenarios, according to three trade sources.
âNo one wants to see markets dislocated. If that happens, it’s bad for customers and for the industry because volumes are effectively drying up,â one of the sources said.
While such contingency planning is not unusual during major events, it underscores Wall Street’s deep concern about how the markets will react when the Fed stops pumping liquidity into the capital markets.
The US Treasury bill market is already experiencing liquidity issues that could spill over into other markets, Bank of America warned in a report on Monday.
The central bank has been buying back state guaranteed bonds since March 2020, adding $ 4 trillion to its balance sheet, as part of an emergency response to the Covid-19 pandemic.
The strategy aimed to stabilize financial markets and ensure adequate access to capital for businesses and other borrowers. It was successful, but also resulted in unprecedented levels of liquidity, helping stock and bond traders enjoy their most profitable period since the 2007-09 financial crisis and leading to record levels of acquisitions and stock market quotes.
Senior bankers are now wondering how the markets will react when this stimulus is taken off the table and what it means for their institutions.
âThe Fed’s cut certainly has the potential to remove some of the ‘foam’ from the market,â said Paul Colone, US-based managing partner at Alantra, a mid-sized global investment bank.
Most bankers, however, don’t expect a repeat of 2013, when the Fed began pulling the stimulus it introduced in the wake of the 2007-2009 global financial crisis.
At the time, volatility skyrocketed as investors tried to get ahead of the Fed by shedding bonds, causing government bond yields to rise and shifting away from riskier assets like stocks.
This time around, there should be enough volatility to increase transaction volumes without disrupting investment banking pipelines, bankers say. The process could actually encourage deals if it alleviates inflation and supply chain issues.
âIf the reduction eases some of the upward pressure on prices, it could benefit many companies,â Colone said.
Investors are looking for creative ways to profit from the volatility created by the downturn and uncertainty about how quickly interest rate hikes will follow, according to several market participants.
âSmart Wall Street traders use a lot of leverage to take advantage of these tensions or pricing errors,â said Matt Freund, co-chief investment officer at Calamos Investments.
Investors are piling up in relative value transactions, betting on whether the rate cuts and future rate hikes by the Fed and other central banks will affect government bond yields more in some countries than in some countries. others, said an FICC trader.
Others are studying the market reaction to the 2013 tapering to inform their strategies.
âThe market is always learning and adapting,â said Freund. “2013 is a lesson that will not be ignored.”