Nearly 30 years later, the 1994 bond rout still casts its shadow over Wall Street, and it raised its spectral head once again when Fed Chairman Jerome Powell called it out in a recent speech as a model for the current interest-rate cycle, contends an article in Bloomberg.
Back in 1994, the Fed was also concerned about the increasing pressure of inflation, and the then-chairman, Alan Greenspan, raised rates for the first time in five years, adding first 25 basis points and then 275 basis points by the end of 1995. While the strategy succeeded—the economy grew 4%—Wall Street reacted wildly. Shocked by the initial rate increase, volatility was rampant, and some estimate as much as $1.5 trillion in losses in the world bond market.
Though the 1994 episode was the most recent, Powell also mentioned two other routs in his speech, according to Bloomberg: 1984 and 1965. Led by Chairman Paul Volcker, the Fed raised rates by 315 basis points starting in 1983. Trading firms were surprised by the increase, and profits in the securities industry tumbled $150 million. And while the 1965 cycle didn’t result in a recession, it did cause chaos in the state and municipal bonds market and a credit crunch in 1966.
Of course, a lot has changed since these three cycles. Back then, the Fed rarely announced its actions publicly, and policy makers have become much more sensitive to the impact their actions have on markets in the years since. More regulations have been put into place to govern capital, liquidity, and market preference, and now firms do trades on an agency basis instead of acting as principal. All of these factors point to a rout being less likely, but that doesn’t mean trading conditions are ideal. Last week, Jeffries Group reported its fixed income trading revenues for the first quarter were down 44%, in an indication that the first quarter, usually the strongest of the year, may be well off the mark for securities firms. And while traders’ business is much more solid than it was in 1965, 1984, and 1994, it’s still cyclical. “A soft landing for the economy may not mean a soft landing for them,” the article notes in conclusion.
