Wall Street Banks Step Up Preparations for Volatility Due to Fed Tapering

Banks of Wall Street are stepping up preparations for the withdrawal of the pandemic stimulus from the Federal Reserve (Fed) in order to ensure that they are able to handle spikes in market volatility, help clients manage their risks and, at the same time, obtain Benefits.

The Federal Reserve is expected to formally announce Wednesday that it will begin to reduce its monthly bond purchases, and sales and operations teams are on the lookout for clients concerned about the ramifications for their portfolios and the longer-term implications of rising bonds. rates and inflation, said several senior bankers.

“This is the most important issue on their minds. People have to renew their portfolios and hedge their risk, ”said the head of fixed income, currency and commodities (FICC) trading at a large world bank, speaking on condition of anonymity.

The foreseeable increase in volatility offers trading desks the opportunity to make a profit by helping clients buy and sell assets, as long as the spread between offers and demands is not so wide, a scenario that, according to bankers, is little likely because the Fed has widely warned of their intentions.

However, in recent weeks banks have been running simulations to make sure their systems can handle phases of volatility similar to those of 2013 in the so-called “taper tantrum”, when a similar but unexpected Fed decision generated a huge shock. in the markets, according to three sources.

“Nobody wants to see dislocated markets. If that happens, it is bad for the clients and for the sector, because the volumes are depleted ”, said one of the sources.

While this type of contingency planning is not unusual around major events, it underscores the deep concern on Wall Street about how markets will react when the Fed stops injecting liquidity into capital markets.

The US Treasury market is already experiencing liquidity problems that could spread, Bank of America warned in a report Monday.

The central bank has been buying government-backed bonds since March 2020, adding $ 4 trillion to its balance sheet, as part of an emergency response to the COVID-19 pandemic.

The strategy was designed to stabilize financial markets and ensure that companies and other borrowers had sufficient access to capital. It was successful, but it also led to unprecedented levels of liquidity, helping equity and bond traders enjoy their most profitable period since the 2007-2009 financial crisis and leading to record levels of acquisitions and IPOs.

Senior banking officials are now grappling with how markets will react when that stimulus is withdrawn and what that means for their institutions.

The reduction of stimulus by the Federal Reserve has the potential to remove some of the “foam” from the market, “said Paul Colone, managing partner at Alantra, a US-based global investment bank.

Most bankers, however, do not expect a repeat of 2013, when the Fed began to withdraw the stimulus it had introduced in the wake of the global financial crisis of 2007-2009.