By Matt Scuffham

NEW YORK (Reuters), Wall Street banks intensify preparations for Federal Reserve withdrawal of pandemic stimulation to make sure they can handle market volatility spikes, manage clients’ risk — and even score a profit.

Many senior bankers stated that clients are increasingly concerned about what the Fed’s decision to stop buying monthly bonds will have on Wednesday. They also worry about long-term effects of rising rates or higher inflation.

They must address this issue. The people must restructure their portfolios and hedge risk,” the chief of fixed income, currencies, and commodities trading (FICC), at a global bank said, speaking under anonymity.

Trade desks can profit from volatility increases by selling and buying securities for their clients. However, the spread between the offers and the bids is not too large that it makes it impossible to create a market. That is a situation bankers claim is unlikely since the Fed gave plenty of notice.

Banks have run simulations over the past weeks in order to test their ability to handle spikes of volatility like 2013’s “taper tantrum”, when markets were in a frenzy after a similar, but unanticipated, Fed decision.

Markets that are dislocated do not want to be seen. According to one source, if that happens, it can be disastrous for clients and the industry as volumes will effectively drop.”

This contingency planning, while not common around major events is a sign of the serious concern Wall Street feels about markets’ reaction to any reduction in liquidity by the Fed.

Bank of America (NYSE) reported Monday that the U.S. Treasuries Market is experiencing liquidity problems which may spill over into other markets.

In an urgent response to the COVID-19 pandemic, the central banks has begun buying government-backed bonds.

It was created to help stabilize the financial market and provide capital to companies as well as other borrowers. It worked, and it resulted also in unparalleled liquidity. Equity and bond traders enjoyed their best period since 2007, which led to record acquisitions and stock markets listings.

Bankers at senior levels are trying to figure out how the markets will respond when stimulus stops being offered and what this means for their institutions.

Paul Colone from U.S., managing partner at Alantra (a mid-market global investment bank), said that “Tapering the Fed sure has the potential for to remove some of this ‘frothiness’ out the market.”

2013. REDUX

However, most bankers don’t expect to see the same scenario as 2013, when the Fed stopped distributing the stimulus it had created in response to the global financial crisis of 2007-2009.

Volatility spiked back then as investors attempted to outdo the Fed by buying bonds. This led to an increase in yields on government bonds and a move away from riskier assets such stocks.

According to bankers, this volatility should not cause disruption of investment banking pipelines but increase trading volumes. If it reduces inflation and concerns about supply chains, the process can encourage deal making.

Colone said that tapering could help alleviate some of the price pressure from rising prices.

According to market participants, investors are seeking creative ways to make a profit from volatility caused by tapering and uncertainty about the timing of interest rate increases.

Matt Freund, Calamos Investments’ co-chief investment officer, stated that Wall Street smart traders use lots of leverage to profit from these tensions and mis-pricings.

One FICC trader stated that investors are investing in relative value trades to bet on the effect of tapering or future interest rate increases by the Fed and other central bankers on government bond yields.

Other analysts are analyzing the market reactions to 2013’s tapering in order to help them plan their strategy.

Freund stated that the market is always learning and adapting. “2013 is not going to go unheeded.”