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By Jamie McGeever
LONDON, Sept 23 (Reuters) - Recent stirrings of long-dormantfinancial market volatility have come in the nick of time for anindustry that has been bleeding revenue and jobs for years, eventhough bankers doubt the secular downsizing of the trading worldcan be reversed.
The prospect of higher U.S. interest rates, and to a lesserextent interest rates, has provided a shot in the arm for marketactivity and banks' trading operations since the half year mark.
Trading in fixed income, currencies and commodities (FICC)has been steadily falling since the 2008 crisis, in large partthanks to a collapse and convergence of interest rates acrossthe developed world that has crushed volatility.
Key measures of price volatility - particularly incurrencies, which in large part trade on interest ratedifferentials - have sunk this year.
Implied volatility in euro/dollar and dollar/yen, the twomost liquid currency pairs in the world, fell to a record low inJuly . U.S. stock market volatility hit a7-year low and bond volatility languished near recentdepths.
Low volatility limits price swings and narrows bid/offerspreads, thereby minimizing banks' scope to make money.Post-crisis regulation such as 'Dodd-Frank' and 'Volcker Rule'legislation in the United States and Basel III banking reformsglobally also effectively restrict banks' ability to hold, tradeand speculate on fixed income and derivatives.
But volatility has since reversed, lifted by U.S. ratespeculation and a range of geopolitical flare-ups that caughtmarkets offguard. Treasury bond and FX market volatility rose tolevels not seen since January.
"Fixed income does show like it's showing a few signs oflife. But we're not out of the woods," said Chris Wheeler,banking analyst at Mediobanca in London.
So far this year, the trading environment has been tough forbanks' FICC operations, which critics sometimes dub"casino banking" and distinguish from traditional investmentservices like underwriting share issues or arranging mergers andacquisitions.
Reuters data show that of 10 major U.S. and Europeaninvestment banks, only Morgan Stanley and Bank ofAmerica-Merrill Lynch raked in higher FICC tradingrevenue in the first half of this year compared with the sameperiod last year.
The other eight saw revenues fall, from Credit Suisse and Societe Generale's 6 percent decline tothe 23 percent slump at Barclays. The average declineacross the 10 banks was 10 percent.
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WHEN THE TREND ISN'T YOUR FRIEND
Major U.S. and European banks will report third-quarterearnings results from next month. That quarter is usually weakbecause it covers the summer months of July and August, leavingSeptember to make up the shortfall.
Credit ratings agency Standard & Poor's argues that whileFICC trading will recover "eventually", revenues will probablystill be between 5 and 10 percent lower this year than last.
But there are encouraging signs as the Fed prepares theground for what will be its first rate hike since June 2006,with the Bank of England to follow a similar path.
Yields on benchmark 10-year U.S. Treasuries have risen morethan 20 basis points so far in September, on track for thebiggest monthly rise this year.
And speculators last week amassed a net short position intwo-year Treasury futures on the Chicago futures exchanges worth98,610 contracts, the biggest bet in over seven years thatshorter-term U.S. bond yields will rise.
"If you're big in foreign exchange and big in U.S. rates,you will start to see things pick up throughout the rest of theyear," said Simon Maughan, product specialist at financial-datasupplier OTAS Technologies.
But the drive to cut costs across the industry shows littlesign of easing. Banks are laying off thousands of staff, notablythe thousands of job losses announced by Barclays in May.
In a report published earlier this month, London-basedconsulting firm Coalition said the reduction in global FICCstaff during the first half of the year was far bigger than thatseen in banks' equities or investment banking divisions.
Headcount fell 9 percent to around 17,700 from 19,600 in thesame period last year, compared with a two percent fall inequities and a one percent fall in investment banking. Since thefirst half of 2011, FICC staffing has shrunk by more than aquarter, Coalition said.
The division that has seen the biggest slump in revenue sofar this year, according to Coalition, is G10 foreign exchangetrading, down 35 percent to $2.7 billion. And in the last twoyears, G10 rates trading revenue has almost halved to $9.8billion.
"Costs will continue to be cut, and the challenges on costswill remain," said the head of rates trading at a bank inLondon. "It's premature to envisage a pick up in hiring."
And pay for those lucky enough to hold onto their jobs isn'trising much, if at all. Options Group, a consultancy, predictsthat average compensation in rates trading will fall this yearby 15 to 20 percent from last year. (Reporting by Jamie McGeever, editing by Louise Heavens)
