Borrowing in U.S. credit markets will approach a record $350 billion in 1978 and the demand for funds should tighten credit conditions as the year progresses, pushing high-quality bond rates to 9 per cent next year and short-term interest rates to around 8 per cent, Salomon Brothers forecast today.
"In 1978, the American credit markets will face their most difficult challenge since the current economic expansion began in early 1975," according to the investment banking firm's annual report on the credit outlook.
The 8 per cent jump in borrowing from an estimated $323 billion this year represents a deceleration in the rate of gain from the 30 per cent increase registered this year over 1976. But coming as it does after several years of economic recovery it "will strain financial capacity somewhat more than was the case in 1977, intensifying market pressures and leading to disappointment among some would be borrowers," the analysis stated.
Most of the increased demand for credit will come from the housing market which is expected to remain strong, corporations which will start using cash faster than they can generate it internally and a sharp rise in federal borrowing which the report said is "an extraordinary development for the fourth year of a business recovery, when revenues usually accelerate while the rise in expenditures slows."
The Salmon Brothers outlook assumes that the U.S. economy will experience real growth of 4.5 to 5 per cent next year, a slight slowdown from 1977, inflation will increase to "the neighborhood of 6.5 per cent" and also add to very large nominal dollar credit demands."
The higher federal outlays and 8 per cent real growth in business capital investment (higher than other forecasts now anticipate) will help to boost the economy, according to the credit outlook.
The U.S. dollar is meanwhile expected to bottom out on foreign currency markets sometime in the first half of 1978.
On the supply side, savings by individuals and businesses will not be sufficient to finance the projected 1978 borrowings so "somewhat greater monetary accomodation will be required" from the Federal Reserve Board, the report stated.
Salomon Brother: economist Henry Kaufman predicted the Fed next year will find itself unable to hold the growth in the basic money supply or M1 below the long range target of 6.5 per cent it has established as desirable in order to fight inflation.
The Salomon Brothers economist said that 1978 will be "a critical year for the economy and inflated" because of the late stage of the recovery, and said it was "very important" that the Carter administration in its January economic messages "state clearly its attitude toward inflation."
Kaufman said that while credit conditions will become progressively more restrictive as 1978 unfolds, he does not anticipate a recurrence of the kind of credit crunch that took place in 1970 and 1974 when interest rates soared.
The Salomon Brothers analysis forecasts an irregular rise in short-term interest rates next year to about 1.23 to 1.75 percentage points over current rates, now somewhere above 6.5 per cent. Long-term yields, as measured by high-grade utility bonds, should approach or exceed 9 per cent, a gain of about 1 percentage point.
Other highlights of the report include:
The expectation that business corporations will increase their external financing to over $100 billion, 21 per cent over this year's estimated $84 billion and 2.6 times greater than the 1975 cyclical low. Most of this increase will come from net new borrowings from commercial banks, estimated at $28 billion in 1973 compared with $18 billion this year.
Continued strength in the housing sector which will continue to provide the bulk of new spending. Consumer installment borrowing will rise more slowly than in 1977, but will reach a new record of $36.5 billion. Residential and other mortgage demands are meanwhile expected to rise to $123 billion from $116 billion this year as housing starts decline moderately to 1.9 million in 1977 but completions continuing to rise sharply.