Bank investors on Friday disregarded the latest signs of strength in the nation's economy, bidding up stock prices despite the specter of rising interest rates.
The government estimated on Friday that the country's gross domestic product, an overall gauge of the economy, expanded at a seasonally adjusted real annual rate of 3.4% in the third quarter.
The figure was higher than generally expected by economists.
But it was under the 4.1% pace of the second quarter and apparently less than feared by investors, who have recently sold off both stocks and bonds of hanks.
"It looks as if both the banks and bonds had been discounted too much in advance of this GDP report," said Michael L. Mayo, regional bank analyst at Lehman Brothers, New York.
The rally broke a long period of bearishness in September and October for banks and bonds that climaxed early last week when the yield on the benchmark 30-year Treasury bond rose past 8%.
The recovery was reflected in the American Banker index of 225 bank stocks.
It slipped 0.68% in the five trading days through Thursday, but for the first time in several weeks outperformed the Dow Jones Industrial Average, which dropped 0.92%
Bank stocks have closely followed the path of the bond market this year as interest rates have risen.
The rally is likely based on the prospect of an slowdown in the economy next year.
"You couldn't have asked for a better-balanced GDP report," said Edward Yardeni, chief economist at C.J. Lawrence/Deutsche Bank Securities Corp. "Solid economic growth, very low inflation, good productivity growth."
He expects the trend to continue. "I think we are going to be very surprised by how well the economy can grow without putting upward pressure on prices."
Mr. Yardeni thinks the Fed will raise rates again at the Nov. 15 meeting of the Federal Open Market Committee, partly to make "a statement about future inflation" and because the risk of starting a recession is low.
The economy continues growing faster than the Fed likes, he said, but rate hikes next year seem unlikely.
"I think the Fed is eventually going to mellow out and enjoy this," Mr. Yardeni said.
Other economists see more of an economic slowdown next year, although not a recession.
The current strength of the economy will last into the holiday season, but then may slow sharply enough next year to warrant rate cuts by the Federal Reserve Board, according to economist S. Jay Levy of Bard College, Annandale, N.Y.
Mr. Levy pointed to the decline in the residential construction category of the GDP report as a sign of a cooling economy.
"It was a small decline, but more significant than the housing start figures," he said.
"Inflation-adjusted GDP growth in the first half will be in the neighborhood of 2%," predicted Mr. Levy, along with David Levy, in a report from the Jerome Levy Economics Institute at Bard.
"Concerns in the money markets will shift on the news of the slowdown," they said. "The Federal Reserve will stop tightening in the first quarter, if not before, and bonds will begin a rally near the turn of the year."
The Levys expect the Treasury's 30-year long bond to fall back to 7% yields by mid-1995.