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June 22nd, 2015 
Awake Goy Among the renewed Greek drama, many missed a key development in the past week, namely Jefferies Q2 earnings, and particularly the company’s fixed income revenue: traditionally a harbinger of profitability for Wall Street’s biggest source of profit (or at least biggest source of profit in the Old Normal). And while not as abysmal as the 56% collapse in the first quarter, in the three months ended May 31 what has traditionally been the bread and butter of Dick Handler’s operation generated just $153 million in revenue.
CEO Handler blamed that decline on a lack of trading in the market and fewer companies selling junk bonds.
To be sure, Q2 was better than the paltry $126 million in the previous quarter, however, the streak of year-over-year declines is now becoming very disturbing for a bank for which an ongoing collapse in fixed income trading will spell certain doom for any ambitious expanion plans, and most likely will result in dramatic headcount reductions to the point where not even fired UBS bankers will be able to find a job at what has long been known as Wall Street’s “safety bank.”
Unfortunately for both Jefferies and all of its other FICC-reliant peers, we have bad news: the drought in fixed income profits is only going to get worse for two main reasons: turnover, as a function of collapsing liquidity in all markets not just debt, has plunged to match the lowest levels in history, and while junk bond turnover is not quite record low yet, it is rapidly approaching its lowest print as well.
But it is not just turnover that is cratering. Even worse is that as electronic trading is increasingly penetrating this final frontier for Virtu (which recently fully took over FX trading leading to now weekly if not daily USD flash crashes following a headline overload), in addition to lack of trading interest (because in a centrally-planned market nobody sells until everybody sells… into a bidless market), the bid/ask spreads are collapsing as every broker fights tooth and nail for those last remaining pennies.
In short: anyone hoping that the Goldmans of the world will fare any better than Jefferies (which unlike the aforementioned hedge fund has far less revenue diversification and is thus forced to extract every possible dollar from the product line) in the fixed income trading drought, will be disappointed, and as a result very soon even that business which until the mid-2000s was Wall Street’s quiet goldmine will become commoditized to the point where Virtu algos make flash crashing junk debt a daily routine.
Ironically, the only thing that can “save” this once-most profitable product line for Wall Street is the full-blown return of risk and volatility, resulting in a surge in trading i.e., selling. Just as ironic: the only thing which can save market cheerleading CNBC’s sinking ratings is a market crash.
Well, CNBC may be too late for saving, but if Wall Street one day realizes that it will be best suited should another crash take place, then one can be certain that that is precisely what will happen. The only question is who will be the sacrificial lamb that unleashes the next risk tsunami in the post-Lehman world.
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