Mary Altaffer
Operation Twist put bank stocks into a spiral. The U.S. Federal Reserve's decision to buy $400-billion (U.S.) of longer-dated Treasuries and sell the same amount of short-term debt by June pushed the yield on the benchmark 10-year note to a record low 1.73 per cent. It's likely to stay under 2 per cent for some time. That squeezes financials across the board.
The most obvious victim is a retail bank's net interest margin, essentially the difference between its cost of borrowing and what it charges for loans. Theoretically, the drop in rates means banks should be able to raise debt capital more cheaply to offset some of the drop in income. But lenders and shareholders alike are wary of banks' exposures and earnings potential. The selloff on Thursday sent most of them even further below book value, with the likes of Citi and Bank of America trading well under half their assets less liabilities. So getting a break on their own interest payments is far from assured.
But the Fed's new policy will also have an impact on fixed-income, currency and commodities traders, traditionally one of the biggest money-spinning operations on Wall Street. They're already struggling thanks to a combination of impending new regulations and a welter of fiscal and economic uncertainties that routinely whack up volatility and scare off customers. Jefferies just reported an 85-per-cent quarter-on-quarter decline in FICC revenue.
Now, add extended, ultra-low interest rates to the mix. In general, that should have a knock-on effect on all manner of fixed-income instruments, narrowing even further the bid-offer spreads that bring in the dough. In the past, investment banks could respond to such moves by increasing their leverage, usually funded with cheap short-term debt. The 2008 financial crisis put paid to that. Seeking extra juice through prop trading is a no-no for most of them, too.
Granted, volatility can help, but not if it comes with the panicky fits and starts that have characterized the past year or so. That tends to keep even the savviest of hedge funds on the sidelines. With fears also returning of another recession, the Fed's move is leaving banks looking little more than a super-long-term investment.