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Treasuries Lose `Masters of Universe' as Volatility Dwindles

2007-02-19 18:14 (New York)


By Elizabeth Stanton

Feb. 20 (Bloomberg) -- The market that once told every

other market what to do, also known as U.S. government

securities, is so dull these days that the world's biggest banks

are losing interest and bowing out.

``Low volatility makes it very hard to generate any

income,'' said E. Craig Coats, who was co-head of fixed-income

at Salomon Brothers in the 1980s, when it was the world's

biggest bond trader.

That's why the firms that underwrite U.S. government debt

may fall to the fewest in 36 years as profits from trading

Treasuries decline along with price swings in the bonds. ``You

have to generate your income by doing massive amounts of

volume,'' said Coats, who was among the elite at Salomon, a firm

whose influence was caricatured in Tom Wolfe's ``Bonfire of the


CIBC World Markets Corp. gave up its so-called primary

dealer franchise this month, reducing the number of firms that

can buy and sell government securities directly with the Federal

Reserve Bank of New York to 21. There haven't been fewer since

1971. The group is down from a high of 46 in 1988.

The average daily change in yields on Treasuries has fallen

to 2.5 basis points this year, from 4.9 basis points in 2001,

and is the lowest since Merrill Lynch & Co. began compiling data

a decade ago. A typical 10-year note trade provides about $1 in

revenue for every $40 it produced in the mid-1980s, said the

head trader at a primary dealer who asked not to be identified

because his firm doesn't disclose details of trading.

Merrill Lynch's MOVE Index, which measures expectations for

Treasury market volatility, fell on Feb. 5 to the lowest since

the firm began tracking the data in 1988. The index, based on

prices of over-the-counter options on notes and bonds, closed at

54.9 that day and finished last week at 60.7.

Decline in Revenue

Opportunities to profit from trading the $4.35 trillion of

outstanding U.S. government debt are disappearing. Revenue from

10-year notes has dwindled to about $30 per $1 million trade

before processing and hedging fees, which average $10 to $15,

said the head trader at the primary dealer. The same trade

earned about $150 in 1999 and $1,200 in the mid-1980s.

The benchmark 10-year note's yield hasn't moved more than

20 basis points in a week since April 2005. The yield on the 4

5/8 percent Treasury note due in February 2017, last week

declined 9 basis points, or 0.09 percentage point, to 4.69

percent. From 2001 to 2006, weekly moves of at least 20 basis

points occurred 31 times.

The number of primary dealers probably will fall in the

next two years, said Jason Evans, head of U.S. government bond

trading in New York at primary dealer Deutsche Bank AG. The

decline won't reduce the ability of investors to buy and sell

large amounts of securities, he said.

`Changing Economics'

``The changing economics of the business is putting a lot

of pressure, especially on the smaller or lower-tier players, to

really question what is the value proposition of maintaining a

dealership,'' said Evans, who previously headed Treasury debt

trading at primary dealer Goldman Sachs Group Inc.

Representatives at Bear Stearns Cos., BNP Paribas, Cantor

Fitzgerald LP, Credit Suisse, Daiwa Securities Group Inc.,

Deutsche Bank, Goldman and JPMorgan Chase & Co. said they were

committed to their primary dealer business. The rest either

declined to comment or didn't respond to calls.

Many firms use their primary dealership to gain more

lucrative business trading and selling credit derivatives or

other types of fixed income, Evans said.

U.S. government debt trading by primary dealers fell last

year for the first time since at least 2001, according to data

compiled by the New York Fed. Transactions averaged $525.2

billion a day, down 5 percent from a record set in 2005. The

daily average rose at least 11 percent a year from 2000 through


Shrinking Group

``The primary dealer community will continue to shrink

based on opportunities for profit in the marketplace,'' said

Patrick Haskell, former head of interest-rate sales and trading

at primary dealer HSBC Bank USA. Haskell quit in December when

the firm cut about 20 jobs from the group.

Twelve of 30 firms in the Bond Market Association's 2000

directory of primary dealers have dropped out. They include ABN

Amro Holding NV, which withdrew in September, and Donaldson,

Lufkin & Jenrette Securities Corp., acquired by Credit Suisse

Group in 2000.

The New York Fed declined to comment, spokeswoman Linda

Ricci said. The market ``is deep and liquid,'' said Jennifer

Zuccarelli, a Treasury Department spokeswoman.

Stable Growth

Price volatility has fallen as global economic growth

became more stable and the Fed and other central banks made

monetary policy more predictable, said Marie Schofield, a senior

portfolio strategist at Columbia Management in Boston. The

investment-management arm of Bank of America Corp. oversees $87

billion of bonds.

The Fed now publishes minutes of policy makers' meetings

three weeks after they occur, compared with six weeks before


``We're seeing lower volatility in terms of economic cycles

and lower volatility in terms of market cycles,'' Schofield

said. ``Things that caused volatility in the past were


Inflation has slowed, leading investors to accept lower and

more stable yields than previously. The annual inflation rate

has averaged 2.8 percent since the start of 2000, down from 3

percent in the 1990s and 5.6 percent in the 1980s. Lower

inflation has enabled the Fed to keep its benchmark overnight

rate lower. It has averaged 3.24 percent this decade, compared

with 5.12 percent in the 1990s and 9.86 percent in the 1980s.

Economic Flexibility

The economy has also benefited from increased flexibility

in the labor market as companies use temporary workers and

overtime to meet production deadlines, according to a New York

Fed staff report published in April 2006.

A January research report by Credit Suisse said the

``persistent trade imbalances with countries that recycle a

substantial portion of their surplus dollars'' back into the

U.S. without hedging against volatility also has contributed to

lower price swings.

John Roberts, a managing director in New York at primary

dealer Barclays Capital Inc. and head of the government

securities division of the Securities Industry and Financial

Markets Association, said the number of primary dealers is

``stable to growing'' in part because the business is key to

winning business from central banks.

For example, Countrywide Financial Corp. became a primary

dealer in 2004 and Cantor Fitzgerald joined the ranks in 2006.

Dealt Out

Almost all of the 17 firms that were primary dealers when

the Fed formalized rules in 1960 have changed their names, been

acquired by other securities companies or gone out of business.

For example, First Boston is now part of Zurich-based Credit

Suisse Group; Salomon Brothers is now owned by Citigroup Inc. in

New York; and PaineWebber Inc. is owned by UBS AG, also in


In the 1980s, as Japan increased purchases of U.S. debt,

six Japanese securities firms became primary dealers: Fuji

Securities Inc., Sanwa Securities Co., Daiwa, Nomura Securities

International Inc., Nikko Securities Co. and Yamaichi

International Inc. Only Nomura and Daiwa remain. Fuji is now

part of Mizuho Financial Group Inc.

CIBC cut the jobs of all nine people involved in trading

Treasuries and other securities based on U.S. interest-rates

when it withdrew this month.

Chris Anderson, a spokesman for CIBC, and Patrick Phalon, a

spokesman for ABN Amro, declined to comment.

Diminishing `Value'

``The value of being a primary dealer has fallen over

time,'' said Brad Hintz, a securities industry analyst at

Sanford C. Bernstein & Co. in New York and the former treasurer

of Morgan Stanley and chief financial officer of Lehman Brothers

Holdings Inc., both primary dealers.

``I'm glad I was in the business when I was,'' said Coats,

who runs the bond division at New York-based KBW Inc., a firm

that isn't a primary dealer.


Following is a table of current primary dealers and their



Firm Headquarters

BNP Paribas Paris

Bank of America Charlotte, North Carolina

Barclays Capital London

Bear Stearns New York

Cantor Fitzgerald New York

Citigroup New York

Countrywide Calabasas, California

Credit Suisse Zurich

Daiwa Securities Tokyo

Deutsche Bank Frankfurt

Dresdner Kleinwort Frankfurt

Goldman Sachs New York

Greenwich Capital Greenwich, Connecticut

HSBC Securities London

JPMorgan Chase New York

Lehman Brothers New York

Merrill Lynch New York

Mizuho Tokyo

Morgan Stanley New York

Nomura Securities Tokyo

UBS Zurich



Following is a table of the original primary dealers in 1960:


J. G. White & Co.

Bartow Leeds & Co.

Briggs, Schaedle & Co.

C.F. Childs & Co.

Merrill Lynch, Pierce, Fenner & Smith Inc.

Discount Corp. of New York

First Boston Corp.

N.Y. Hanseatic Corp.

Aubrey G. Lanston & Co.

Wm. E. Pollock Government Securities Inc.

Chas E. Quincy & Co.

D.W. Rich & Co.

Salomon Brothers & Hutzler

Bankers Trust Co.

Chemical Bank & Trust Co.

Continental Illinois National Bank & Trust Co.

Guaranty Trust Co.


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