A resurgence in foreign currency activity is driving trading revenues at major banks to all-time highs.
In the first quarter, major trading banks and brokerages including Citicorp, Merrill Lynch & Co., and Chase Manhattan Corp. saw revenues derived from trading soar to a combined $2.2 billion, reversing three consecutive quarters of falling revenues at most trading desks.
Analysts foresee similar results in the second quarter thanks to a big change in the pattern of trading. Investors, they say, have returned to speculating on foreign currencies after a two-year hiatus.
"People are starting to take currency risk again," said Jeremy Fand, senior foreign exchange strategist at BankBoston Corp. "Since the beginning of 1997, dollar volatility has increased dramatically."
Volatility has also increased markedly in two of the world's most traded currencies, the Japanese yen and the German mark. A stagnant economy in Japan and high unemployment and uncertainty about European monetary union have caused the currencies to swing widely in recent months. The yen has soared to as much as 127 to the dollar, a five-year high, while the mark has ranged from about 1.5 per dollar in December to 1.73 recently.
Such sudden twists might turn the hair of corporate treasurers prematurely white, but they've been good news for trading banks, most of which reported stagnant or falling trading revenues as 1996 progressed.
"You want your customers to think they have to do something," said David S. Berry, director of research at Keefe, Bruyette & Woods, who follows money-center banks.
Chase Manhattan tallied a record $183 million in trading revenues during the first quarter, and Citicorp reported $182 million. And Merrill Lynch weighed in with a whopping $273 million in first quarter revenues.
Analysts say currency speculation is regaining favor because bond yields in most foreign countries have been dwindling. Falling yields have en masse forced managers of foreign bond portfolios to seek additional sources of money to enhance disappointing returns.
But the reason portfolio managers may be changing their positions all at once may be related to the proliferation of foreign exchange derivatives they have bought. These instruments, designed to protect buyers from market fluctuations, may actually cause volatility to become more severe once the genie is out of the bottle.
"People buy derivatives often because they believe nothing is going to happen. So when there is a move, it's exacerbated because people are positioned to not expect it," said Gary Johnson, director of fixed-income research at Scudder, Stevens & Clark Inc. who also manages the firm's international bond fund and global bond fund.
"Derivatives has kept volatility out of the market for longer periods of time than before, but volatility is more acute when it returns now," he added.
By it nature, volatility is tough to predict and trading revenues can rise or drop suddenly. J.P. Morgan & Co., which does a lot of proprietary trading and derivatives business, has already warned investors not to expect the same trading revenues in the second quarter as seen in the first.
But Keefe's Mr. Berry thinks other banks, such as Citibank and Chase Manhattan, will continue to post strong trading numbers in the second, owing to their strong foreign exchange operations. "This is quite the time to be in that business," he said.