The Fed turns up the steam
New York — Mexico is still shaky. Brazil is wobbling. The United States economy seems stuck in quicksand. Faced with this dismal December picture, the Federal Reserve Board has moved more aggressively than many economists anticipated to lower interest rates.
The Fed's action on Monday - lowering the discount rate from 9 percent to 81/ 2 percent - is expected to act as a catalyst, encouraging banks to drop the prime interest rate from 111/2 percent to 11 percent sometime this week.Economists and money market observers, however, don't expect the cut to carry over to consumer rates until the new year. In January, if the Fed cuts the discount rate another half a percent - as is widely foreseen - consumers may see some relief.
The Fed's move caught many economists on Wall Street by surprise. Normally, the investment community senses imminent cuts in the discount rate. Investors had failed to foresee this cut and the stock market rallied strongly the morning after it was announced. The bond markets also reacted strongly, with short-term interest rates falling one-half of a percent and long-term bonds dropping nearly a quarter of a percent in early trading.
Donald Maude, chairman of the interest-rate policy committee at Merrill Lynch & Co., the brokerage firm, noted that normally the Federal Reserve would have waited for some weakness in the monetary aggregates to make its move. Economists had expected this to happen later this month.
But the Fed is faced with a host of problems. First, the dam holding the reservoir of international debts is springing leaks. Brazil has now followed Mexico to the consortium of international organizations that lends money to countries unable to meet their debts. Over the weekend, the Reagan administration lined up an additional $1.5 billion in emergency funding for the Brazilians. Only two weeks ago, Brazil borrowed $1.2 billion. Mr. Maude commented, ''(Fed chairman Paul A.) Volcker had a meeting in Europe over the weekend and the markets hadn't been that nervous over the Brazilian situation. It makes you wonder if there are things we haven't seen on the surface.''
The lowering of interest rates, points out Irwin Kellner, senior vice-president and chief economist for Manufacturers Hanover Trust Company, will help to ease the debt burden on such countries as Brazil. Furthermore, Mr. Kellner says, lower rates will help to stimulate the US economy, which in turn should increase demand for exports from the debtor countries.
''There is no doubt about it,'' Mr. Kellner said, ''lower interest rates can lead to a resolution of other parts of their problems.''
On the foreign exchange markets, the dollar declined with lower interest rates.
The Fed's actions were also inspired in part by the sluggish movement of the US economy. The government reported Monday that inventories equaled 1.55 months' sales in October, the highest level since in June of 1975, when the figure was 1 .58 months. This rise indicates consumers are still keeping their hands in their pockets. Furthermore, economists are predicting that unemployment should continue to rise in the first quarter, perhaps peaking at 11 to 111/2 percent. This has created political pressures on the Fed to lower rates.
William Sullivan, senior vice-president of the Bank of New York, commented: ''I think the political pressures are below the surface. It's broader than whether or not to give the economy a little juice. It's more a reflection of the election. Congress got a mandate to get the economy moving quickly.''
Frank Mastrapasqua, chief economist for Smith Barney, Harris Upham & Co., agreed, noting, ''In a world plagued with overcapacity, significant debt burdens , and rising protectionism, the monetary authorities have little choice but to maintain their focus on augmenting liquidity.''
There is little doubt the Fed's actions will be welcomed by the Treasury. Over the next two weeks, it expects to sell securities worth $18.5 billion. In fact, Arnold Moskowitz, first vice-president at Dean Witter Reynolds, another brokerage, says the Fed's timing on lowering the discount rate was related to the central bank's desire to make its move before the auctions so as not to disrupt them. Maintaining orderly markets is important to the government, since it will become an even larger borrower in the first quarter of next year - when it must borrow a record $50 billion. Next year, Mr. Moskowitz estimates, the government deficit will swell to $192 billion, including $15 billion to $20 billion it will raise to help bail out countries like Brazil.
Although the prime interest rate has fallen steadily since October, consumer lending rates have remained high. With unemployment rising, banks have tried to keep their margins on consumer loans high to protect themselves from delinquencies. And, ironically, the new money-market accounts the banks can now offer are acting to hold rates up, since the banks are battling hard to get consumer deposits. When they give higher interest rates, they must charge higher rates.
Mr. Kellner says consumer rates should start to fall in January. Initially, he expects auto loans to drop 1 to 11/2 percent from the current 16 to 17 percent level. Mortgage rates have already fallen, and should continue to drop, economists agree.
However, mortgage rates are still high, points out Charles Lieberman, an economist with Morgan Stanley & Co., investment bankers, adding, ''Homes are selling a bit better than expected,'' considering how high rates are.