Short-term interest rates begin what may become a slow slide
Interest rates, like autumn leaves, have started to fall. The prime rate, after hitting a peak of 21.5 percent at the start of the year , will ease to 19 percent across the country this week. And, economists and businessmen now believe rates will continue to drop through the end of the year.
"I think we can see the prime reduced by another 50-100 basis points [about one-half to 1 percent] by the end of the month," says David Cross, senior economist at Chase Econometrics. However, he quickly adds, "There will be no precipitous decline. Interest rates will be very stickly coming down."
Marc Goloven, vice-president and economist at Manufacturers Hanover Trust, agrees that rates will be sliding this year and predicts the prime interest rate will hit 16-17 percent by year-end.
Still further declines are possible, hypothesizes Leif Olsen, chief economist for Citibank, if interest rates return to historical patterns -- reflecting inflation and the cost of money. In that case, Mr. Olsen says, interest rates might decline to 11 or 12 percent. Mr Olsen's forecast, however, is among the most optimistic.
There are several reasons for the drop in interest rates.
* the economy is beginning to falter. "Demand for credit is easing," says Mr. Olsen of Citibank, as business winds down. New orders have dropped, unemployment is starting to rise, and industrial production is falling. In late August, notes Dr. Edward Yardeni of E. F. Hutton Businessmen began to cut back. As an example, he cites the low level of auto output General Motors has set for the fourth quarter -- its lowest production pace since strike-ridden 1970 -- and record unemployment among minorities and black teen-agers.
In September, says Mr. Olsen, the Economy appears to have faltered further. However, he doesn't believe the current dip will degenerate into a recession, which could drive interest rates down even further.
* The Federal Reserve Board now has some leeway to loosen its constrictive grasp on the money supply. Even Henry Kaufman, the Salomon Brothers Economist famous for his predictions of sky high interest rates, believes the Federal Reserve Board will opt to ease rates somewhat. The Fed met to discuss its strategy Tuesday. should the central bank loosen the purse strings. Mr. Kaufman says, the prime lending rate would fall "Grudgingly," and economic growth would resume.
* Political pressure is mounting for a reduction in rates. Treasury Secretary Donald Regan has suggested that interest rates are too high, and this message was no doubt received by the Fed. Congress, at the same time, is under pressure from businessmen in financial trouble to act.
Sen. John Melcher (D) of Montana was unsuccessful last week in tacking on an amendment to the debt ceiling extension bill asking the president to discuss high interest rates with Fed Chairman, Paul A. Volcker. According to Wayne Mehl , an aide to the senator, the amendment will be added to every appropriations bill introduced on the floor of the Senate.
According to Maury N. Harris, a vice-president at Paine Webber, the President also can influence the Fed through his appointment of a new Fed vice-chairman who would consider the Fed's impact on the President's economic program.
Whether the drop in short-term interest rates will spill over to the long-term bond markets and the mortgage markets, however, is open to debate. Mr. Cross believes it will be "more difficult to make any dent in the level of mortgage rates." Some studies have indicated that the All-Savers certificate could reduce mortgage rates by about 2 percent. However, Mr. Cross says the new certificates -- if they are successful -- will only lower mortgage rates by 1 percent. Thus, he is forecasting only a weak recovery in the housing sector until the second half of next year when he believes mortgage rates could dip to 14.5 percent from their current 16-18 percent levels.