A movement upward of key short-term interest rates and some other financial market developments have convinced a growing number of analysts that the Federal Reserve decided last week to tighten credit another small notch.
The interest rate on federal funds--reserves loaned by one financial institution to another--has risen close to 9 1/2 percent this week, and the analysts said that the slow way in which the Fed has chosen to add reserves to the banking system contributed to the increase.
For the week ended July 13, the federal funds rate averaged 9.2 percent. The Fed's policymaking group, the Federal Open Market Committee, met July 12 and 13 to consider whether to continue the modest credit tightening begun in late May, and that was increased somewhat in late June.
Federal Reserve Chairman Paul A. Volcker will disclose today in testimony to the House Banking, Finance and Urban Affairs Committee that the FOMC reaffirmed its money-growth targets for the broad money measures M2 and M3, sources said. Volcker will tell the committee that, for 1984, those target ranges will be lowered by one-half percentage point compared to this year's targets.
The sources also said that the FOMC decided to seek growth of the M1 money measure for the remainder of this year at an annual rate of 5 percent to 9 percent from its level in the second quarter.
For the week ended July 13, M1 stood at $514.1 billion, about $16 billion abvove the upper limit of the 4 percent to 8 percent growth range the Fed set earlier for the period from the fourth quarter of 1982 to the fourth quarter of this year.
Volcker told the Senate Banking, Housing and Urban Affairs Committee last week that returning M1 to its target range by the end of this year is not a matter of high priority for the Fed. Choosing a new base from which M1 growth would be measured would be in line with that view.
M1 includes currency in circulation, checking deposits at financial institutions and travelers' checks. M2 includes all of M1 plus savings deposits, small time deposits, money market deposit accounts, most money market mutual fund shares and some other items. M3, the broadest money measure, includes M2 plus large certificates of deposit and some other items.
Among the analysts saying the Fed has tightened again was Charles Lieberman, a senior economist at Morgan Stanley & Co. Lieberman estimates that the Fed is now seeking to leave the banking system as a whole about $300 million or so short of the amount of reserves required by the system's level of deposits, up from $200 million or $250 million previously.
Since some banks each week have more reserves than they need, actual borrowing from the Fed, the only source of reserves for the banking system as a whole, will be more than $300 million. In the week ended July 13, financial institutions borrowed $1.147 billion from the central bank.
Prior to the May tightening, Lieberman said, the Fed was providing just about exactly the amount of reserves needed. For the next several weeks, the Fed appeared to be aiming at a so-called net borrowed position for the system of about $50 million to $100 million. After a June 23 FOMC conference by telephone, the net borrowed figure increased to more than $200 million.
As the Fed provided fewer reserves than needed, the federal funds rate rose from about 8 1/2 percent--the level of the discount rate (the interest rate institutions pay when they borrow reserves from the Fed)--to 9 1/2 percent. Most other short-term interest rates have risen comparably or in some cases even more.
Economist Allen Sinai of Data Resources Inc., described the Fed's actions since May as "leaning against the wind." Sinai explained, "With the economy growing strongly and M1 rising in response to transactions requirements, the increased demand for reserves by commercial banks will exert upward pressure on the federal funds and related markets. By only slowly responding in the provision of reserves . . . , the central bank can lean against the demand-side pressure on the financial markets, tending to push short-term interest rates higher until control of the money supply is regained."
This gradual process involves little risk of aborting the economic recovery while "signaling the intention of the central bank to stand against inflation in a reasonable manner," Sinai said.
In coming weeks, he predicted, the Fed "will become somewhat more restrictive yet, but only gently and gradually."