Bank stocks rallied Friday on the strength of a surge in the government bond market.

The price of the 30-year Treasury bond rose about 1 1/2 points, cutting the yield to a record 5.94%.

The Labor Department sparked the rally by reporting that nonfarm payrolls dropped 39,000 in August. The market had anticipated an increase of 140,000 to 150,000.

Market analysts said banks will continue to show rising profits despite the weak economy.

Fat Reserve Cushion

Banks have built up, hefty loan-loss reserves that will cushion earnings while the economy stumbles.

In addition, banks with big trading operations are seen benefiting from the bond market rally.

The two biggest traders, J.P. Morgan & Co. and Bankers Trust New York Corp., were the primary beneficiaries of Friday's bond rally.

Morgan's shares jumped $1.875 to $77.25. Bankers Trust's shares were up $1.375 cents to $81.875.

Broader Market Advances

Most bank stocks were up on Friday in step with the overall market. The Dow Jones industrial average gained, 7.83 points to 3,633.93. in the over-the-counter market, bank stocks outperformed the overall market. The bank index rose 1.58 points, against a gain of 1.06 points for the Nasdaq composite.

"Some of the sector's gains come from investors repositioning themselves for third-quarter earnings," said Alison Deans, analyst at Smith Barney Shearson. "Investors worry about net interest margins and asset yields, but the third-quarter earnings will look good."

Takeover news and rumors continued to be a major mover of bank stocks.

UJB Financial Corp.'s shares were up $2.375 to $30.625. as investors focused again on the perennial takeover candidate.

Friday's gains ended an otherwise sluggish week for the sector on a high note. For the five trading days ended Thursday, the American Banker index lost 0.92%. versus a 0.61% loss for the Dow Jones industrials.

Thomas Brown, an analyst with Donaldson, Lufkin & Jenrette Securities Corp., believes a tug-of-war is going on between two investor camps.

One group fears that net interest margins will narrow because long-term interest rates will continue to fall while short-term interest rates remain stable or rise.

The other group believes that banks have a better chance to show earnings gains than other industries.

"In my book, anything that shows the economy is in a slow-growth period supports bank stocks as well as the broader market," said Mr. Brown.

Robert Bonelli. executive director of the Ernst Financial Group, said. "There's no place else to put your money but the stock market."

Hungry for Yield

With the long-term bond below 6%, investors are looking for yield. Some bank stocks, including First Union Corp., Comerica Inc., and National City Corp., have dividend yields of around 4%. If the stocks gain, the overall return can easily exceed that of the long bond.

Apparently, Friday's bond rally did not immediately reawaken investors' fears about a possibility of a tightening of net interest margins.

Concerns about narrowing net interest margins have surfaced repeatedly over the past year. The most recent bout came just a few weeks ago, amid a rally in the 30-year bond.

Investors were concerned that banks would get a lower yield on their securities portfolios. Bank share prices tumbled for a few days before regaining ground.

Analysts said the movement in the long bond will not lead to narrower margins, mostly because banks invest in shorter-term Treasuries.

"The long bond itself tends not to have a direct impact on bank margins," said John Leonard, an analyst with Salomon Brothers Inc.

The sluggish economy, the absence of growth in inflation, and the low yields on 30-year Treasuries led some analysts to speculate that the Federal Reserve will lower its target for the federal funds rate to stimulate the economy. The target is now 3%.

For the first time since the government began regular sales of 30-year bonds. the yield on long-term Treasuries is lower than the prime rate. 6% at most banks since July 1992.

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