As we come to the end of the first quarter and see that the Treasury has completed most of its $55-$58 billion borrowing needs, we are surprised that the bond markets are dead in the water. There is no direction, a lot of anxieties, and a lot of hope. The past several months have witnessed the largest monetary explosion in history, so it is small wonder that investors are at a loss as to what to do.
There are five major factors that will probably determine the direction of interest rates this year: the health of the economy, the direction of oil prices, inflation, monetary policy and fiscal policy, or budget situation. All are interrelated and all could have either positive or negative effects on interest rates. A brief review of these situations will prove beneficial.
The economy continues to return mixed signals. Most economists predicted a slow recovery, but after January and February's good numbers, many economists raised their estimates for real GNP growth to about 4 percent for 1983. Should the recovery be stronger than this, credit demands from the private sector could grow and clash with the Treasury's needs, forcing rates higher. Should the recovery falter, the reverse is true and a lack of credit needs could allow rates to decline.
If oil prices continue to fall into the $20 to $25 area, it could act as a shot in the arm for the recovery, and it could also help reduce the Consumer Price Index.
Inflation itself has been surprisingly good and although the rate is still falling, analysts think the inflation rate for 1983 will be 4.5 percent or lower. When one looks at the 10.65 percent return available on long Treasury bonds, the real interest rate of 6.15 percent is still extremely attractive.
Monetary and fiscal policy are probably causing the most confusion to investors. It appears that the Federal Reserve has become especially concerned about the growth of the M1 monetary aggregate and has ever so slightly set about reducing any excess reserves in the banking system. This has moved short-term rates about 1/2 of a point higher.
The administration's budget is still being worked over in Congress. The House-passed budget resolution undermines two of the pillars of the president's economic program: defense spending, and surely the 10 percent tax cut for this year. The House version also increases government spending again. Consequently, the battle of the budget is sure to drag on and add more confusion to the interest rate outlook.
The bottom line is that long-term government interest rates will probably exist in a trading range of 10 to 11.25 percent. Favorable results in any one of the five factors could easily push rates toward 10 percent or lower. Conversely, unfavorable results could easily push long rates toward 11.25 percent or higher. It's a tough one to call, and at the moment, the near-term direction of rates is still unclear.James E. Lebherz has 23 years' experience in fixed-income investments.