How Four Banks Scored a Perfect Trading Quarter

(Fortune) -- Most traders think the market is something that yields to intelligence and effort, or what proportion can be summoned of both. But it's rare that entire institutions dominate the market as perfectly as Goldman Sachs, JP Morgan, Bank of America, and Citigroup did in the first quarter of this year. Between January 1 and March 31, the four banks made money on every single business day.

The first quarter is traditionally the most profitable for the banks, and this year's was buoyed by robust gains in the equity markets in February and March. But perfection demands a more perfect explanation, particularly given jitters over impending regulation, the threat of new litigation, and the looming withdrawal of the government stimulus that is keeping the U.S. economy afloat.

Also, it wasn't just one bank with perfect results. It was four.

So how did they do it? First among many explanations is a shift in how banks are making profits. Increasingly, Wall Street has turned its focus to "market-making." Banks are getting in the middle of trades-matching buyers and sellers to each other and charging fees on either side-rather than taking huge bets on stocks or bonds or currencies or commodities with their own money. While that shift doesn't mitigate risk, per se, it makes daily profits much less dependent on whether markets rise and fall.

Further, many of these banks' institutional customers are still executing trades out of necessity rather than speculation. Volatility, particularly in the euro, British pound, and specific commodity markets, created an environment where anyone hedging themselves in these markets has had to buy or sell continually, often at great expense. Similarly, banks have profited as once-risk-averse clients have rushed out of treasuries and bonds and into equities and other riskier asset classes.

Another factor benefiting banks is the steep yield curve-which shows the yields of bonds of different maturities. When the yield curve is very steep, as it is now, short-term bonds pay very low yields but long-term bonds pay much more. This benefits banks in a few different ways. First, since rates on short-term debt are low, banks are able to borrow cheaply. Among other things, this allows them to leverage their investments-and make more profit, if they bet correctly.

A steep curve also allows for carry trade along the yield curve-another profitable opportunity for banks. Traders can borrow short-term debt, then relend the money out, long-term, at higher rates, and pocket the difference. Incredibly, with the average interest rate on ten-year Treasury bonds at 3.7 percent last quarter, banks could borrow at next to nothing and lend back to the government at a higher rate.

More nefarious explanations have also been suggested. On March 31, the last day of the quarter, the Fed ended its program to buy $1.25 trillion of mortgage-backed securities. Some market-watchers have suggested that banks may have bought up risky assets during the quarter, knowing that if the investments worked out they could keep the profits, and if they went bust the Fed would absorb the losses.

Whatever the cause of the perfect quarter, it comes as part of a pattern. Goldman (GS, Fortune 500) president Gary Cohn revealed on May 11 that the bank had only recorded 11 loss days in the prior 12 months. So while some luck is involved in stringing together 61 up-days in a row, the trend of success isn't a fluke. The larger story may well be broader shifts on Wall Street-to acting as market-makers, for instance-that have facilitated this run.