Last month, the U.S. federal reserve raised interest rates for the second time in three months, the first of three rate hikes expected in 2017. While other markets — Japan, Europe and Canada — are maintaining record-low rates, inflation in the U.S. is returning to target levels, leaving the era of perpetual low rates behind. Despite fears of instability in the wake of the presidential election, the economy is growing and markets are embracing rising rates.
This is welcome news for the fixed income, currencies and commodities (FICC) market, which has strengthened in the first quarter of 2017, compared to 2016. New issue volumes and average daily trading volumes of U.S. corporate bonds have gone up by 17.8% and 14.2% respectively in the first two months of 2017, compared to the same period last year. This continues to grow upon a 9% increase in bond trading revenue over 2016 — the first such increase since 2012.
The current state of bond markets, compared to equity markets, is still considerably archaic. There is no centralized information source for bond pricing data and 75% of global investment grade corporate bonds are traded via phone call.
Digitization, however, is gradually taking place in FICC market. Electronic bond trading, in particular, has made some promising progress. Replacing the old "request for quote" (RFQ) electronic trading system is the new all-to-all trading system where all market participants, regardless of buy side or sell side, can make a market. The electronic match-making algorithm has reinvigorated the FICC trading to some extent. According to Greenwich Associates, roughly 50% of U.S. Treasuries are now traded electronically.
With the penetration of digitization in FICC market, automation can be achieved. For example, many hedge funds have started programming algorithms to trade bonds.
The digitization in FICC is here to stay and will benefit all parties involved.
In the short-term, banks may increase their headcount in FICC as a result of the recent rate hikes, but the long-term trend will see employee numbers decreasing as a result of increased digitization and automation on both the buy side and sell side. This was precipitated by the low-rate environment but will not be reversed with the end of record-low rates. Investment firms, having first embraced digitization in response to a challenging fiscal environment, will continue to do so.
As the economy regains its footing, the digitization of capital markets will allow investors, issuers, and brokers to reap the benefits of greater efficiencies. Resistance to this trend, and the preservation of outdated and inefficient practices will only slow growth. While short-term increases in hiring may restore confidence, the reality is that those jobs, founded upon archaic transaction practices, cannot be permanent.
Automation and AI should not spur fears of reduced employment in FICC markets — rather, they are indicative of a re-allocation of skills towards automation that will spur employment growth. At Goldman Sachs, where the equities trading desk had been reduced to only two employees, jobs were not eliminated entirely but instead shifted to those with the digital skills required to upkeep a robust automated trading network.
The best way for the FICC markets to transition out of a low-rate environment and into a market that seems perpetually marked by volatility is to embrace, not resist, the move towards digitization. While interest rate hikes may increase profits and hirings, this should not vindicate outdated methods. Ultimately, maintaining faith in innovations originally meant to offset a struggling economy is the best course of action. Those innovations were good then, and remain so.
Vuk Magdelinic is the CEO and co-founder of Overbond, which digitizes bond origination and issuance. Prior to that, he led digital transformation programs at Deutsche Bank and BNY Mellon and also previously worked at CIBC, PwC and Deloitte.
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