Bank bond spreads improved Tuesday in the absence of bad news.
The difference between the yields on 10-year bank bonds and comparable Treasuries tightened by as much as 5 basis points, market experts said.
Traders said that optimism in the stock market has washed over into the bank bond market, which has been pummelled in the last two weeks. Stabilization in emerging-market debt and junk bonds has also made investors more confident about the market, traders said.
Bank bond spreads had widened by 20 basis points starting two weeks ago, when investors grew anxious about economic upheaval in foreign economies.
J.P. Morgan Securities Inc. noted that spreads on bank bonds have improved substantially, but told clients not to expect a strong rally.
"We think that banks still look cheap relative to industrials, but that further relative spread tightening will be difficult to come by this month," wrote bank bond analyst Scott O'Donnell in a recent report.
Mr. O'Donnell said he is maintaining his neutral rating on the sector.
Though money-center bonds "offer better value, investors are still exposed to the volatility" in the international markets, Mr. O'Donnell said.
Another concern, the analyst said, is that some money-centers could take a "kitchen sink" approach to the fourth quarter, when they "identify and reserve for portfolio risks."
Adding reserves during the fourth quarter is likely to put pressure on earnings and could cause bond spreads to widen.
J.P. Morgan told clients to buy finance company and insurance bonds instead of bank debt.
Mr. O'Donnell said that J.P. Morgan forecasts a mild U.S. recession, but expects the business operations of higher-rated finance and insurance companies to weather the downturn, judging by their performance during the 1990 recession.
In other news, PaineWebber Inc. told bond holders to curtail their buying of First Tennessee National Corp.'s bank bonds. First Tennessee issued $150 million in 10-year notes last week at 125 basis points over Treasuries.First Tennessee is a well-run financial institution with excellent earnings potential, but the bonds are somewhat pricey, said Joseph J. Labriola, head of corporate bond research, in a recent report.
Investors should buy First Tennessee paper if spreads widen by another 5 to 8 basis points, the analyst said.