As this year began, most money market forecasters were looking for a steady but gradual climb in interest rates through 1978.
But interest rates so far this year have climbed higher and moved faster than anyone expected, spooking the stock and bond markets, and leading analysts to revise their 1978 borrowing cost forecasts upward.
The jump in interest rates has been most pronounced on the long end, with Pacific Telephone & Telegraph Co., a Ball System unit, recently selling $300 million in 40 year debentures at just a hair under 9 per cent, a level that many analysts predicted would not be seen until much later in 1978.
Behind the sudden jump in rates was the Federal Reserve Board's surprise Jan. 6 announcement that it was raising the discount rate - what banks must pay to borrow from the nation's central bank - from 6 to 6.5 per cent. The action was aimed at bolstering the battered dollar on foreign exchange market - the first time in this decade that Feb has tailored monetary policy to primarily deal with international concerns.
On top of this, the Fed moved to tighten domestic monetary policy another notch, raising the target federal funds rate - what banks charge each otner for overnight borrowing of excess reserves - to 6.75 per cent from 6.5 per cent.
And the nation's commerical banks raised their prime lending rate from 7,75 per cent to 8 per cent, the first increase in 11 weeks.
While short-term rates have climbed across the board, the impact on longer maturity fixed income instruments, which usually move more slowly, has been dramatic.
In less than a month, the yields on top-rated industrial, utility and government bonds have gone up anywhere from 25 to 40 basis points (each basis point is the equivalent of 0.01 per cent ).
The sharp run-up in rates has heightened concerns that runaway borrowing costs could throttle down the economic recovery. Also, by drawing funds out of saving insitutions, it could slice available market, currently a source of considerable strength for the economy.
"As we go through the year, the struggle for credit will intensify, and will reach a rate that will disintermediate," said Salomon Brothers chief economist Henry Kaufman. He was referring to the outflows of funds from savings certificates into higher yielding fixed income investiments. "If it doesn't happen next week, it will happen later,"
Kaufman has tacked on about a half percentage point increase on his previous interest rate forecast for 1978. But the end of the year, he now says, interest rates on AAA utility bonds could reach 8.75 per cent, and federal funds, which are now at 6.75 per cent, could hit 8 per cent.
Besides the Fed's recent discount rate hike, there are growing expectations that inflation will accelerate in 1978, adding to the pressure on interest rates. The Fed is also faced with the new surge in the country's money supply in December and January which some feel could cause it to raise short-term interest rates another quarter per cent soon.
Preliminary indications, however, are that the Federal Reserve Board's open market committee - when it held its montly meeting on Tuesday to set the near-term course for monetary policy - decided to wait and see whether the 8 per cent growth in the basic money supply in December and the sharp $4 billion jump in the most recent reporting week will be followed by other large increases before it goes ahead and further tightens the money spigot.
Lawrence A. Kudlow, vice president and monetary economist for Paine Webber, said "probably no action will take place until the open of the monetary aggregates." He added that that may not occur before mid-February.
But Kudlow predicated that the federal funds target rate, which the Fed uses as its benchmark for open market operations, will probably hit 7.5 per cent by April. Rates on longer term obligations should only experience slight additional upward pressure, he said, since their runup already has been faster than anticipated. These rates may be indeed overshot the appriopriate levels for the time being, he added.
Other money market observers, while acknowledging the recent surge in rates, say the overall outlook for interest rates in 1978 has not changed too much - only the timing.
"Long-term interest rates climbed more sharply than the Fed desired," said David M. Jones, vice president with Aurbey G. Lanston & Co.,which specializes in government securities, and he pointed out the earlier this week the Fed was actively buying older coupon issues "in aneffort to tone up the market and bouy up sentiment."
"Inthe long-term area, I feel we may not be too far from a peak in interest rates for 1978," said Jones, "though the short rates may have a bit further to go in the spring." The short rates, he predicted, "will peak in late April or early May, and then may stabilize if not actually turn downward later in the year."
William N. Henry Griggs, economist with J. Henry Schroder Bank & Trust Co., also noted recent Fed moves to bring some of the longer term rates down slightly, partly to calm the atmosphere for upcoming announcements on Treasury debt refinancing operations.
"They want to be sure when we come into the refunding period they stand and does not assume the worst when insitutions start bidding" on the Treasury obligations, said Griggs.
The Fed moves have helped the corporate bond markets to calm down, although they remain vulnerable. In past few months, many institutions and some individuals have been liquidating their bond portfolios, putting their money into short-term instrutments, like Treasury bills, in the anticipation that they ca reinvest in long bonds later this year when yields will be higher.
Investors are "in a position of wait and see" on bonds, commenting Walter J. Burkett, Merrill Lynch's vice president in the corporate bond department and the manager of its retail trading area. He noted that the Pacific Telephone issue had an enthusiastic investor response - "9 per cent is always a magic number" - and that other new issues might be similarly appealing in coming months.
"Not all portfolio managers are in concert about the final outcome in interest rates, and that's what makes a market," said Burkett. "I would, however, be ever so cautious, and would pick and choose carefully what is forthcoming in the new issue calendar, or what is available in the secondary market," he advised. "If it was my personal money, I would be patient. The signs of any turn or downward trend in interest rates will be predictable, and to read those signs will not require a massive genius."