Henry Kaufman, perhaps Wall Street's most widely followed economist, predicted today that by the second half of the year, long-term interest rates would return to or surpass the record high levels they hit last October.
Those interest rates nearly killed the bond market, where companies and governments raise money they don't have to pay back for years, and helped choke off the housing market. Kaufman, chief economist for the giant investment banking firm of Salomon Brothers Inc., said the high rates he expects later this year again will wreak havoc on corporations, home buyers, savings institutions and state and local governments.
Corporations, burdened with short-term loans that they must refinance continuously, will be unable to return their balance sheets to a healthier state. Housing, which has been in a severe depression for the past few years, will not recover in 1982. State and local governments, which face reduced federal aid, will have trouble selling their securities.
Normally during a recession and the early stages of an economic recovery interest rates decline, private borrowing declines and companies borrow in the bond market to replace their short-term debts to banks and other lenders. "But 1982 will not be a typical first year of a business recovery," Kaufman told reporters at a breakfast briefing.
The investment needs of companies and with their lack of liquidity (cash) will combine to push up business borrowing. At the same time, the huge federal deficit--the result of big tax cuts plus the impact of the recession--will sharply boost U.S. Treasury borrowing. He said he does not expect anything but a temporary improvement in inflation.
Economists at Citibank, New York's largest, took a more optimistic tone today. They predicted that interest rates and inflation will decline in 1982 and during the rest of the decade.
The bank economists predicted that short-term rates would zig-zag early in 1982, but would decline on balance unless fears about the growth of the money supply and heavy borrowing by the federal government "crowding out" the private sector cause markets to overreact. The Citibank economists hit squarely at economists like Kaufman who think the federal government will elbow out private borrowers and cause rates to rise.
Kaufman said the government will have to borrow $135 billion this year, while short-term corporate borrowing alone will surpass $140 billion.
The Salomon Brothers economist, also one of Wall Street's leading pessimists, said his estimate of federal borrowing needs may be low. The calculations were done four weeks ago when Kaufman estimated a federal deficit of $80 billion this year. He said the deficit probably will be $90 billion but scoffed at leaks from the administration that estimate a deficit tens of billions of dollars higher than $90 billion.
Once the recession is over and the economy appears back on the road to a slow recovery, Kaufman predicted the Federal Reserve Board, the nation's central bank, will return to a tight monetary policy.
It was the Federal Reserve's loosening of the credit reins that helped push down both long-term and short-term interest rates during the last few months of the year, although rates have risen from the lows they hit during late November and early December.
Kaufman predicted an economic recovery would begin in the spring, although it will be a subdued one. He said Salomon Brothers expects real economic growth to be less than one percent for all of 1982.
Even that projection is highly uncertain, he cautioned, because it assumes the Federal Reserve will be able to manage its monetary policy "without having to raise money rates dramatically...If the central bank returns to a strict adherence to monetarism, the risk is for a much slower recovery in the second half of the year."
Kaufman criticized so-called monetarism, in which the central bank conducts its operations in a way designed to keep within a target range the growth of the money supply (essentially checking accounts and cash in circulation).
He called for a review of both monetary and spending policies, which seem to have conflicting goals. Big tax cuts have pushed the federal budget into deficit, leaving the so-called fight against inflation to the high interest rates engendered by a tight monetary policy. Kaufman said that rather than trying to control the money supply, the Federal Reserve should try to control the growth of credit.
Kaufman said that by the second half of the year, and perhaps earlier, interest rates will be driven back to last October's levels, when the rate on long-term Treasury bonds rose to 15 1/4 percent. Rates on the highest grade bonds issued by utilities climbed to 18 percent. Kaufman said he doubts the prime rate, the interest banks use as a reference point for short-term loans to their best corporate customers, will rise above the 21 1/2 percent peak it hit last year. However, Kaufman said, the prime lending rate has less meaning today than it did years ago.