Mexico's currency crisis could ultimately help bank stocks if it prompts Fed monetary managers to defer or temper a further rate increase this month.
Before the stunning plunge of the peso, Wall Street considered another rate hike by the Federal Reserve System a near certainty, and investment strategies had been planned accordingly. Now there are doubts.
"It's possible the Fed could decide to lie low," said Edward Yardeni, chief economist at C.J. Lawrence/Deutsche Bank Securities Corp., New York.
"A little earlier it was seen as a done deal. The only debate had been whether the tightening would be by 50, 75 or 100 (basis points on short- term rates)," he said.
"I don't think Orange County would have held them back, but there is just too much funny stuff going on globally, too much instability in world financial markets right now," he said.
Orange County, California, rocked the financial markets last month when it entered bankruptcy after rising rates spawned huge losses in its highly leveraged investment portfolio.
"The initial reaction in the markets, if they perceive the Fed is being held back from tightening, will probably be some downward pressure on bond prices and bank stocks," Mr. Yardeni said.
Ultimately, however, the impact could be beneficial. "There is always a 'flight to quality' whenever global markets are disrupted, and where are you going to get better quality with less risk than in the U.S. right now?" he said.
If rates are raised at the Jan. 31-Feb.l meeting of the central bank's federal open market committee, as Mr. Yardeni and others still generally expect, the rates may go up by less than previously expected.
"I doubt seriously they would consider not moving at all, but they may stick to 50 (basis points) instead of anything higher," said Mickey D. Levy, chief economist at NationsBanc Capital Markets Inc.
"The Fed likes to maintain an even keel in times of turmoil, and they are aware that their credit tightening can have unintended consequences," he said. "But I think their perception remains that the cost of not moving is higher than moving further."
"I'm betting that rates are going up," said George M. Salem, banking analyst at Gerard Klauer Mattison & Co., New York. "The Fed may hold off at the January meeting since it would be a way to help Mexico, but that would be temporary."
The analyst expects the central bank to push up short-term rates by another 100 basis points by the middle of the year.
That would lift the Fed's target rate for overnight loans of bank reserves, the federal funds rate, to 6.5% and elevate the discount rate for Fed loans to member banks to 5.25% Both rates were at 3% a year ago.
In the meantime, Mr. Salem thinks that "what is happening in Mexico is vitally important for the money-center banks, because that was one of their feedbags."
The analyst said he previously felt that shares of major banks, particularly New York's Citicorp, deserved to sell at 15 times earnings for the portion of their earnings derived from Latin American countries and other so-called emerging markets.
But Mr. Salem now questions whether the term "emerging markets" continues to be applicable if such countries are prone to serious financial disruptions like those that have occurred in Mexico and earlier in Hong Kong.
"These earnings may not be worth a P/E that high," he said. "If Latin America is the reason you like a stock, and Latin America has problems, you have got to like that stock less." A P/E of five on such earnings might be more appropriate, he added.