Investors have fled bank bonds in the past week, worried that the Federal Reserve may hike interest rates this year.

Spreads between yields of bank bonds and those of Treasuries started to widen after last Friday's Labor Department report that consumer prices jumped 0.7% in April-a sign of inflation. The widening accelerated Tuesday when the Fed's Open Market Committee changed its "bias" to a tightening stance from a neutral one.

By Thursday bids for 10-year bonds of Fleet Financial Group had widened to 122 points over Treasuries, from 117. J.P. Morgan & Co. bonds were at 124 basis points, up from 120. Bank of America Corp. bonds were 115 over Treasuries, up from 111.

Spreads have been widening since early this month, when they were as much as 15 points tighter.

The higher bids show investors are demanding greater returns to take on the risk of bank debt.

Some analysts said the concerns over higher rates may be overblown and that the recent action has created a buying opportunity.

"People think the sky is falling-but it's not," said John Otis, an analyst for Bear, Stearns & Co. "This little backup is not going to derail bank asset quality."

Banks are well insulated against a 25- or 50-basis-point hike in the federal funds rate, these analysts said. Banks have hedged against interest rate dependence buy beefing up fee-based businesses and trading interest rate swaps and futures.

Bank bond spreads over Treasuries floated around 70 basis points a year ago, when the federal funds rate was 75 points higher than today's 4.75%. That means there is plenty of room for bond spreads to tighten now, Mr. Otis said.

Others advised investors to remain cautious.

Higher interest rates should not negatively affect net interest margins of banks, but the "perception of higher interest rates" hurting banks "is going to drive spreads wider," said Joseph J. Labriola, an analyst for PaineWebber Inc., New York. "Spreads are going to vacillate for a while."

What's more, investors still have scars from the bond market meltdown in the third quarter, when money-center bank bond spreads ballooned to the 200-basis-point range.

"If the emerging market were to rear its ugly head again, you would see things get real shaky again," said Carl de Jounge, an analyst for Deutsche Bank Securities in New York.

Bondholders' anticipation of an increase in bank bond issuance by yearend may also prevent spreads from tightening. More bonds hitting the market would depress prices and keep spreads over Treasuries wider.

Still, Mr. de Jounge said oversupply from a market flurry would be a "near-term blip."

"Once that funding has been finished, you will see a resumption of tightening," he said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.