Bank bonds have been among the hottest investments in the last two weeks, but some analysts think the good times may be coming to an end.
Turbulence in the Middle East and economic troubles brewing overseas could make bond investors dump their bank bonds.
The last two weeks for bank bond investors, however, have been golden.
Bank bond spreads-the difference between their yields and those of Treasuries-have tightened substantially, meaning that bond investors are coming off the sidelines to invest in the securities.
According to traders, the spreads on 10-year bank paper have tightened by as much as 50 basis points in the last two weeks.
The last two interest rate cuts and the shoring up of eroding foreign economies and financial institutions have spurred many investors to start buying bank bonds again, said bank bond analyst Stanley August of First Union Capital Markets in Charlotte, N.C.
On Friday the International Monetary Fund struck a deal to give $41 billion in aid to bolster Brazil's flagging economy. Investors were also cheered by the Japanese government's plan to unveil a package to improve that country's languishing financial institutions.
"Everybody is clamoring for bank paper," the analyst said. One of the key reasons for the demand is that "bank bonds were oversold to begin with."
Interest in banks has been so keen that spreads on bank bonds are likely to stay firm even if the Federal Reserve does not ease interest rates a third time, Mr. August added.
Bank stocks have sagged in the last week as investors became more doubtful that the Federal Reserve would again ease rates. The Fed cut short-term interest rates Sept. 29 and Oct. 15.
Bond investors are confident that the Fed will cut interest rates when it is necessary, Mr. August said.
"I don't think bank bond spreads would widen substantially if the Federal Reserve does not cut interest rates."
In fact, too much easing could create the opposite fact.
"If the Fed cuts interest rates too much, investors may start to speculate more," Mr. August said.
Bank bond analyst John Otis of Bear, Stearns & Co. said bank bonds will probably encounter a volatile market.
Too many issues in the international arena have yet to be resolved, Mr. Otis said.
The United States' troubles with Iraq and political turmoil in Turkey and Venezuela could make investors sell their bonds.
Mr. Otis said, "Investors may also sell because spreads have tightened so much that they might want to sell and buy the credits back later."
