Interest rates have been going up, and in financial markets a growing sense of unease is palpable, just as the economy is emerging smartly from recession. Despite the ebullient forecast by Treasury Secretary Donald T. Regan--a flat prediction that the prime rate would be down from present levels by the end of the year--others fear that interest rates will go through the roof again, foreshortening the recovery.
Henry Kaufman of Salomon Bros. says flatly that "higher interest rates" are probable after the mid- July meeting of the main Federal Reserve policy board, the Federal Open Market Committee. On WTTG-Channel 5's "Panorama," economic adviser Martin S. Feldstein indicated he could not go as far as Regan did in predicting lower rates.
The course of interest rates is not only a question of enormous significance for jobs and profits, but loaded with overtones on the political front: if a feared upsurge in interest rates shows up in force prior to the November 1984 elections, it could turn what now seems to be an advantage for the GOP into a plus for the Democrats.
Rates have been edging up since October 1982. But as recently as May 4, 90-day Treasury bills--which a year ago had been yielding over 13 percent, were as low as 8.01 percent. Since then, T-bills have moved up steadily, and are now close to 9 percent. Other rates, including long-term rates, have also crept up.
Those analysts who think Secretary Regan too optimistic agree that the bottom of the current interest rate cycle has come and gone, and that the recent firming trend hasn't been completed.
The prospect for a further rise in American interest rates is viewed in European countries as a potential catastrophe for themselves and the world economy. And anyone who has anything to do with the Third World debt problem gets chills thinking about higher interest rates: most observers are convinced that it was only last year's dramatic slide in interest rates, triggered by a change in Fed policy, that kept many of the big debtor countries in Latin America from going belly-up.
But there is less accord on how the recovery here would be affected by higher interest rates. One school of thought, which has wide acceptance in New York financial markets, and privately within the Federal Reserve, is that interest rates can rise "moderately" (that means 1 to 2 points more in short-term rates) without turning off the recovery.
To be sure, that much of an increase--bringing T-bills to between 10 and 11 percent--might dampen the pace of the upturn, without choking it off. But this group would view a slight cooling down of the present expansion as not altogether a bad thing because it would also reduce the threat of regenerating inflation.
Economist Alan Greenspan, for example, says that it is only the international situation that is preventing the Fed from tightening monetary policy "modestly now, since such action probably would entail minimum domestic costs and might yield enormous benefits."
Another group of serious economists and analysts fears that once such an upward trend in interest rates gets started, it will be nurtured by worries over large federal deficits. They think that higher interest rates will in fact choke off recovery, constraining investment and housing, and keeping exchange rates high. This would perpetuate high unemployment, and help assure continued huge trade deficits that feed protectionist demands.
One specific interest-rate analysis receiving a great deal of attention from the professionals was offered June 16 by Albert Wojnilower, managing director and chief economist of The First Boston Corp., sometimes known as "Dr. Death" when paired with Kaufman as "Dr. Doom":
"Faced with the unpleasant choice between raising interest rates now or perhaps having them rise less controllably later, the authorities will probably try to steer a middle course. Rates will be allowed to move up, but reluctantly," he said.
" . . . the bottom line remains that business is moving up too strongly to be easily restrained. That also means that it is moving up too strongly for interest rate stability."
The Wojnilower analysis makes a subtle and important point: because of the deregulation in financial markets, even a big increase in interest rates, which in years gone by would have choked off economic expansion, may not do it now.
The reason: any boost in short-term interest rates would quickly be matched by money-market funds--those in and out of banks--representing hundreds of billions of dollars of business and individual deposits. Thus, says Wojnilower, "in contrast with the past, the public would be able to keep its money spendable without having to forego earning market interest rates."
The underlying meaning of this conclusion is that deregulation--which has scrapped interest-rate ceilings and allowed all sorts of institutions, ranging from chain stores to brokerage houses, to act more like banks--has robbed the Federal Reserve of some of the crunching power it used to have. Therefore, it takes a larger shift in interest rates than formerly to affect the economy.
"Basically," says a thoughtful and well-informed observer, "it's not realistic or good for the country to exaggerate the role of the Fed or of Chairman Paul Volcker. It implies much more leverage than they have."