Why experts see a continued slide in interest rates
Boston — Here are two happy views:
''Interest rates should be lower through the balance of this year and a good part of 1983.'' - Frank Mastrapasqua, economist, Smith Barney Harris Upham & Co.
''Interest rates are likely to continue to decline on average; I stress the word average because nothing moves in a straight line.'' - Leif Olsen, chief economist, Citibank.
Such cheerful opinions are being listened to nowadays with more attention. The interest-rate bears of Wall Street, such as Henry Kaufman of Salomon Brothers and Albert M. Wojnilower of First Boston Corp., have been chastened by this summer's decline in rates.
Reflecting the drop in rates, the price of long-term bonds rose from $96 on June 23 to $117 last week - an enormous gain in a brief period. Those who followed the advice of the gloomy bond-market analysts lost much of a highly profitable opportunity before their advisers finally changed their minds.
The decline in interest rates, of course, concerns people other than managers of investment pools. It's also relevant to the average consumer.
Mr. Mastrapasqua, relatively optimistic, guesses that mortgage rates might drop as low as 12 percent by mid-1983. Car loans might dip to 13 percent in early 1983. At those levels, the housing and auto industries should pick up more zip.
But another well-known Wall Street economist, H. Erich Heinemann, argues that both short- and long-term rates are close to their low points now in the ''current move,'' which started last July. ''By Thanksgiving,'' he predicts, ''interest rates will be showing an upward bias again.'' He figures rates will peak out in the winter well below the highs in the spring of 1982 - a moderate forecast by the old standards of such super-bears as Kaufman and Wojnilower.
There are several elements economists look at when forecasting interest rates. These include:
* Inflation. Investors expect to make a real return after discounting inflation. If they anticipate high future inflation, they will insist on higher interest rates. If interest rates are seen as declining, they may be more willing to loan at lower rates.
Mr. Mastrapasqua's and Mr. Olsen's bullish forecasts partially depend on their belief that inflation is not only headed lower, but will be recognized by investors as declining. Citibank's Olsen, for instance, noted that the current rate for 90-day bank certificates of deposit or other commercial IOUs is running about 10.5 to 11 percent. That is more than 4 percent above the 5- to 6-percent rate of inflation this year.
''There is plenty of room for rates to come down,'' he says. ''Even in boom times in the last 20 years, interest rates never have previously gone above 4 percent higher than the inflation rate.'' A more normal ''real'' interest rate might be 1 or 2 percent.
Smith Barney's Mastrapasqua figures inflation will come down even further in coming months, as it usually does at the start of a business expansion. But he goes even further to predict ''a reversal of the secular rise in inflation and interest rates that was particularly evident in the last two decades.'' Inflation and interest rates tend to go up and down with the business cycle, but they also have notched up higher during each expansion than in the previous expansion - that is, on a secular, or very long-term, basis. Now, Mastrapasqua believes, inflation and rates could move down on a secular basis over the years ahead.
One reason is that the major factor in business costs - wages and salaries - are not increasing so fast. Increase in compensation per man hour peaked at 10.6 percent in the fourth quarter of 1980. In the second quarter of this year it rose 7.5 percent on a year-to-year basis, comparable to the lows reached in 1976 . Mastrapasqua figures it could decline another 1 to 1.5 percent by the end of 1983. In other words, employees should expect, on average, lower wage gains next year.
* Monetary policy. Many people believe that so-called tight money means higher interest rates. In fact, the reverse is proving true. When the Federal Reserve System pumps more money into the economy, interest rates soon jump. There may be a short down trend as the extra money becomes available. But investors quickly decide that printing too much money will result in more inflation, and thus higher interest rates. Or they expect the Fed to have to trim the growth of money and at least temporarily shove up rates - and thus act in anticipation of that move.
''In the spring of 1980,'' recalls Robert S. Smith, a Chase Manhattan Bank economist, ''the Fed pumped in reserves to drive rates down, only to find them skyrocketing in the wake of a monetary explosion. To again allow excessive money growth can only have the same result.''
That's also what worries Erich Heinemann. He suspects the fall election, the slowness of the recovery, and other factors will force the Fed to become more ''accommodative.'' That largely explains his forecast for temporarily higher rates. The forecast of lower interest rates by Citibank's Mr. Olsen's hangs on the Fed not departing significantly from its present antiinflationary monetary policy.
* Demand for credit. The price of money depends, like that of any other commodity, on the demand-supply balance. Various money-market watchers publish periodically estimates of credit flows, such as that by Morgan Guaranty Trust Co. in the accompanying table.
Morgan expects total credit demand in the second half of this year to reach an estimated $270 billion - up $48 billion from the first half. One reason is heavy Treasury borrowing, reflecting a sag in tax revenues because of the recession. These are calculated at more than $100 billion - almost double borrowing in the last half of 1981.
The Treasury borrowed some $11.75 billion only last week. Rates were somewhat higher than expected, but below those of similar issues sold earlier. For instance, the Treasury auctioned $2.75 billion of 20-year notes Thursday at an average yield of 11.68 percent, compared to 11.82 percent when it sold similar bonds in January 1981.
Heavy Treasury borrowing does not automatically mean higher interest rates. They have often fallen in the past when federal borrowing has risen.
One reason that such a repeat performance could be possible now is the anticipated decline in borrowing by business. Companies, explained Mastrapasqua, are engaged in ''reliquification'' - that is, busily attempting to reduce their heavy debts by trimming inventory (along with the need for financing that inventory) and cutting back on capital-spending projects. They also are trying to reduce short-term debt (under one year in maturity) and replace it with longer-term and less worrisome debt. This shift, Mastrapasqua notes, has already resulted in a 3- or 4-percent spread between short-term and long-term rates, tempting investors to move into longer-term investments. During 1980-81, short-term rates were higher than long-term rates and lenders had little reason to take the risk of loaning their money for years into the future.
The table also reflects the slump in the housing market, and thus in the demand for mortgage money, and the relatively modest need for further consumer credit after subtracting repayment of consumer debt.
* Supply of credit. The fear of a great shortage of credit as a result of ''crowding out'' by the federal government is starting to fade. One reason is the increase in the savings rate.
Citibank's Olsen anticipates rapid growth in the supply of credit in the next few months. That will be a sharp change from the last three years, when the supply of funds to the credit markets stagnated in nominal terms and declined in real terms after removing the effect of inflation.
With today's high interest rates, people are being attracted away from buying ''things'' to investments in the various financial markets. Moreover, the continuing monthly reports of relatively low increases in the various price levels are at last persuading people that the Fed's antiinflationary policy is working. Thus they are more willing to lend.
In the past, says Mr. Olsen, the supply of funds to the credit markets has grown as much as 30 percent in one year. If repeated, that would mean a growth of $147.6 billion on Morgan Guaranty's calculated demand for credit of $492 billion this year. (In such tables, demand must always equal supply.) That's just about the same amount as the expected total of federal government issues this year.
Such calculations are obviously rough. And what if those with money are less enthusiastic about lending it than Mr. Olsen hopes? Nonetheless, a growing number of money-market experts see a good chance that, even though interest rates will remain far above their low levels of, say, the 1960s, they should head down in the next 18 months. So it may well cost less to borrow to buy a refrigerator, a car, or a house. If that happens, the widespread fear of the current tiny recovery in the economy losing momentum in the sands of high interest rates should fade.
Who borrows how much (Billions of dollars, not seasonally adjusted) 1980 1981 1982*
First Second First Second First Second half half half half half half Mortgages 52.4 8.7 53.1 45.7 35.0 40.0 Consumer credit -10.2 12.5 6.3 19.0 0.0 20.0 Federal government 24.7 55.1 33.5 54.3 42.0 103.0 Federal agencies 21.7 20.7 19.7 24.3 25.0 26.0 State, local government 9.0 17.8 12.3 13.5 13.0 16.0 Corporate and foreign 25.1 13.3 13.7 11.2 15.0 25.0 bonds and notes Other business borrowing 40.1 26.7 70.8 53.4 72.0 25.0 (nonfarm) All other credit 12.9 23.8 16.8 7.5 20.0 15.0 Total credit demand 176.0 238.5 226.3 229.0 222.0 270.0 * Estimated. Because of rounding, components may not add up to totals. Source: Morgan Guaranty Trust Company