Fed curb on bank commodity trading - good for CTA's?

The Fed is planning to move forward with rules to limit the trading of commodities by banks. The potential risks from trading commodities are thought to be great enough to require more capital or the risk of a potential taxpayer bailout, so Fed views a limit on bank commodity activity is warranted. It is not clear the specific form this will take, but it is likely that banks will be out of the physical commodity business and certainty will have a reduced presence in the trading of cash and derivatives. Serving as commodity merchant banks and dealers involved with storage and distribution may be a thing of the past.

An important source of trading capital will be gone from these markets which means risk and opportunities in commodity markets will change significantly.  At a high level, there will likely be a greater imbalance between hedges and speculators which means that time varying risk premia will be larger and more volatile. Banks will not be committing capital to provide liquidity and serve the needs of different market participants. 

This exit by banks will also led to a decline in liquidity or at least a transition in the liquidity providers in these markets. If less capital is committed, there will be an increase in liquidity risk premia. There is also be a potential break in the link between cash and futures. Banks have developed strong cash networks which have led to consistent activity in arbitrage between futures and cash markets. An important area of financial research has been the discussion on the limits to arbitrage. If financing and capital are not available to these markets, there will be more and persistent arbitrage opportunities. Of course, this just places markets in a state of flux. The exit of capital will increase profits for those who are willing to commit capital in the future. If profit margins are high enough substitute capital will be found; however, in the mean time, there is the potential for greater market dislocations.

For those who speculate in commodity markets, there can be an significant increase in trading opportunities in this new environment. Price shocks could become more extended so there could be larger trends in markets. This may especially be the case over short trading horizons. There may be greater deviations from fair value which will also offer more trading opportunities through arbitrage and spread trading. Alternatively, volatility in markets could increase such that there will be greater noise from short-term market dislocations. Finding trends and exploiting opportunities may be more difficult. 

The commodity market action will be more consistent with behavior before the ascent of bank trading. This new "old world" environment could be good for the traders who understand how to exploit hedging behavior and can provide liquidity.