Trading Desks Keep on Humming

Traders have become magicians. Not only can they make crafty products appear practically from thin air, they are also churning out profit as easily as conjurors pull rabbits from hats.

Shares in Banco Santander of Spain fell 7 percent on Tuesday on debt fears.

Look at the first quarter. Not long ago, analysts expected fixed-income, currency and commodities desks to have a relatively humdrum quarter. Yet most such units at Wall Street firms reported stellar numbers.

That is hard to square with much of the evidence. Some businesses hit a rough patch as the Greek debt crisis arose in February. Bid-ask spreads on most products are also now much lower than they were a year ago. Leverage has crept up a bit, but is still pretty tame. And competition is rising now that the likes of UBS and Bank of America Merrill Lynch are back on their feet.

There were some obvious hot spots: the Greek debt crisis and the related volatility on the euro, for example. And with interest rates still low, investors got bolder in their hunt for yield — and the bumper primary market for new high-yield bonds gave a lift to the trading desks. On top of that, write-downs on bad assets were largely negligible.

But that still does not explain how so many banks cranked out so much trading revenue. UBS generated more than four times as much as it did in the last three months of 2009. Goldman Sachs brought in a record $7.4 billion.

The banks keep their secrets closely guarded, even though fixed-income trading desks can account for more than half of total revenue. Goldman said little but that all desks had a “very good, but not excellent” quarter. Morgan Stanley acknowledged that commodities trading was not as lucrative, while Deutsche Bank suggested currencies and government bond trading were slower.

Most said clients were busy, despite the February lull. The pointed comment seems intended to show they are profiting as middlemen, not as prop-trading bettors. But several also noted the benefits of tightening spreads, which implies they made a bundle just from holding a lot of paper: mere inventory gains to some, just a huge bet with the bank’s own money to others.

But traders shouldn’t get too cocky about their routine. Rising rates will hurt. And the business is vulnerable to regulatory reform. Legislation restricting trade in lucrative over-the-counter derivatives would be particularly painful. But last quarter, at least, the reliance on — and the mystery of — fixed-income trading units showed through.