First-quarter "FICC blow-up": even Wall Street giant Goldman Sachs was hit hard by the Iran war.

Impacted by the sudden shock to global macro rate expectations due to the Iran War, Wall Street giant Goldman Sachs unexpectedly suffered a setback in its first-quarter Fixed Income, Commodities, and Currencies (FICC) business, with its rates trading division becoming the main drag on related revenue declines.

According to sources cited by the media, Goldman's first-quarter FICC business revenues recorded a 10% decrease, not only missing analysts' previous expectations of a 10% growth, but also lagging far behind the double-digit growth achieved by JPMorgan, Citigroup, and Morgan Stanley during the same period.

The Iran War outbreak at the end of February heightened market concerns about high inflation and slowing economic growth, forcing investors to reprice the risk of rate hikes by the US Federal Reserve and other major global central banks. This sharp reversal in macro expectations directly broke through Goldman Sachs’ preset rate hedges, dealing a substantial blow.

Although the FICC division performed poorly, the same violent market fluctuations drove Goldman Sachs’ equity trading business to a record high in revenues, supporting the bank in achieving its highest overall quarterly profit in five years, partially offsetting the mistakes in fixed income trading.

Hedging Strategy Broken by Macro Reversal

The direct reason for Goldman Sachs’s performance blow-up this time was a misjudgment in its forecast of the US rate path amid potential economic slowdown.

According to sources cited by the media, Goldman Sachs previously held a series of positions related to technology and artificial intelligence, assets that typically perform poorly during economic weakness. As a risk-balancing hedge, the bank also established positions betting on Fed rate cuts, hoping to profit if economic growth faltered.

However, the Iran War completely overturned this strategy combination. Geopolitical conflict pushed up inflation expectations, prompting markets to price in risks that the Fed, Bank of England and European Central Bank might raise borrowing costs.

The sharp turn in expectations badly hit Goldman Sachs’ bets on rate cuts. Additionally, sources said that during the market turbulence triggered by the conflict, Goldman Sachs suffered some losses when assisting clients with unwinds and liquidations.

The Backlash of Aggressive Risk Appetite

In the realm of fixed income trading, Goldman Sachs has always been one of the dominant players on Wall Street.

Since the 2008 financial crisis, many Wall Street banks' trading divisions greatly reduced directional market risk exposures, focusing more on providing financing and trading facilitation for clients. However, Goldman Sachs is still known for being more willing than peers to take market risk.

Among these, the rates division at Goldman has always been known internally for daring to take on substantial risk. This business is led by Anshul Sehgal, co-head of Goldman FICC, whose superior, Ashok Varadhan, Goldman’s most senior trader, was also once a rates trader. This more aggressive risk appetite can generate extremely lucrative profits when calls are correct, but when the market moves unexpectedly, it results in significant underperformance.

Management Response and Performance Divergence

In response to the much weaker-than-expected performance of the FICC division, Goldman management offered relatively muted comments.

Goldman CFO Denis Coleman told analysts this week that the declines in rates and mortgage trading revenues were due to a "more challenging market-making environment," partially offset by strong performance in currency and commodity trading.

Goldman President John Waldron argued at a meeting Wednesday that this "is actually a very good fixed income quarter." He explained that in periods of sharp volatility in rates and commodities, "you might get caught in traffic, and things may not go your way at any particular moment."

Ultimately, the dim performance of the FICC division made Goldman Sachs’ most profitable quarter in five years appear slightly lackluster. However, thanks to the same wild market turbulence that caught the FICC division off guard, Goldman’s equity trading business set a historical record with $5.3 billion in revenues, creating a marked internal performance divergence.

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