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Are Banks A Good Bet?

Written by A Forex View From Afar on Monday, July 28, 2008

How much confidence do the financial markets have in banks? None, Zero, Nada – No matter how you say it, the result remains the same

TheLFB Jul 28 XLFThe XLF index, which tracks financial companies in the U.S. markets, has dropped more than 50% since the high that was made last summer and now the index is looking ready to push the price action under the 20 points area. This certainly shows investors’ trust is limited and that they do not want to be caught near any financial shares.

Then we have the bond yields of financial companies. Bonds are usually a form of loans used by financial companies to finance their asset acquisitions. A higher yield means investors do not value the bond and see it as a risky one (due to the reverse correlation between the bonds’ price and yield). Yields for financial companies are now at the highest point since 2000, but back then, the Fed Funds were at 6.5%. Right now, the Fed Funds are at 2%, making the spread between Treasuries, (considered a safe haven) and financial bonds, very steep. This shows investors require a higher premium for holding those bonds. For example, Lehman Brothers borrowing costs for its five-year bonds rose to 7.7%, while 5 year Treasuries are now trading at 3.26%, making the spread 4.44%

Financial shares are down
Even if the spread does not seem huge, we are speaking about losses reaching millions of dollars. Over time, higher premiums can translate into balance sheet losses since banks will have to pay back more to their lenders. If yields remain so high, and they probably will, the financials will have to carry a big weight over the coming quarters, longer than previously estimated.

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