Interest rates rose steadily through the first half of the year and declined by almost the same degree during the second half. Coinciding with this movement was the behavior of the economy, which was strong during the first half of the year and then deteriorated during the latter half. Interwoven into these movements were several complex underlying events that resulted in the economy and interest rates following similar paths.
The major factors affecting the direction of interest rates were the federal budget deficit, the merchandise trade deficit, the strong dollar, the behavior of the monetary aggregates (especially M1), the economy and, lastly, Federal Reserve policy. Amazingly, all these events were interrelated and dovetailed into one another.
Perhaps the main force was the federal budget deficit, which totaled $175.3 billion in fiscal year 1984. The deficit did a couple of things: It continued to stimulate the economy during the first half of the year and, in so doing, raised inflationary expectations, which in turn helped to raise rates. Next, the deficit, which had to be financed, contributed in a large way to the demand for credit, which also placed upward pressure on rates. Lastly, the high levels of both nominal and real interest rates in the United States attracted foreign capital, which helped to finance our budget deficit and also to aid our economic recovery.
This inflow of foreign capital bolstered the dollar to record levels in the foreign exchange market. This strong dollar made imports cheap and our exports expensive. Money Market
In the big scheme of things, the Federal Reserve was the dominant factor in the direction of short-term interest rates. As the economy roared ahead during the first half of the year, the Fed was stingy in supplying reserves to support economic growth. This forced short-term rates higher. But when it appeared that the economy was in trouble, the Fed changed course in mid-August, and short-term rates began to decline. Interestingly enough, in an unusual sequence, short-term rates followed long-term rates lower.
During these changes, short-term market rates remained below the administered prime rate. As a result, it became much less expensive for corporate borrowers to raise money by issuing unsecured promissory notes known as commercial paper. That market exploded with a $56 billion increase in outstanding paper. Phenomenal growth occurred, especially in the nonfinancial sector, to the tune of a $25 billion increase. Tax-exempt commercial paper also expanded in 1984. By year's end, 96 programs had about $7.2 billion of paper outstanding, a growth of 21 percent for the year.
As loan demand increased, banks began issuing more certificates of deposit. The amount of new CDs issued was about $37 billion. At the same time, as our exports began to decline more heavily in the second half of the year, the commercial bank volume of bankers' acceptances, which are issued to help finance our exports, tumbled from their peak of $82 billion in late June.
In late 1983, the returns on money market funds became higher than the returns available on money market demand accounts (MMDA) of financial institutions. During 1984, the rate advantage aided the money maket funds in growing by some $50 billion from a year earlier. U.S. Treasury/Agency
Because of the federal budget deficit and the need to roll over maturing government debt, the Treasury continued to dominate the marketplace. As of Oct. 31, the average maturity of the $1.61 trillion in interest-bearing debt was 4 years and 5 months. At year's end, the public debt stood at $1.641 trillion, up $241 billion over the calendar year. The interest paid on the public debt in fiscal 1984 was $154 billion.
Unofficially, the Treasury's total borrowing was $1.080 trillion. Of this amount, $190 billion represented new money raised; $8.8 billion of this new money came from off-budget items and was financed for the Federal Financing Bank through Treasury offerings. Municipal --
Tax-exempts' interest rates rose gradually through the first half of the year, plateaued during June and July, and then came down as the bond market rally began, but much more slowly than the rates for taxable securities. The main reason was the passage in late June of the Deficit Reduction Act of 1984, which unleashed a flood of housing, airport and other industrial revenue issues. Through June, $33 billion of new long-term munis had been sold. During the last half of 1984, $59.41 billion were sold for a 1984 total of $92.41 billion.
As the taxable issues outperformed the tax-exempt issues during the last half of the year, the ratio of the tax-exempt returns to the taxable returns moved to very high and attractive levels. Part of this increase occurred from November on, when the tax-exempt market adjusted to the 35 percent marginal income tax rate that the Treaasury had proposed. Corporates and Euros
The domestic corporate bond market established a new record for the issuance of corporate debt. Bonds worth $50.4 billion were sold, up from $35 billion last year. There were several other notable factors to be observed. First was the dramatic decline in equity sales by corporations: from $38.6 billion in 1983 to only $12.851 billion in 1984. Corporations took advantage of the good stock market in 1983 to help redress their balance sheets, but 1984 was a period to pay down and extend debt.
Very little debt was issued with maturities beyond 10 years. Corporations did not want to be saddled with long-term commitments with high rates. As a result, about 23 percent of the new issues had maturities of five years or less.
Lastly, the makeup of the issues changed: Almost half of the new securities was mortgage-related debt.
But this does not tell the whole story, because a record volume of financing by U.S. corporations occurred in the international bond market. Approximately $21.2 billion in U.S. debt was floated overseas. When coupled with the domestic volume of corporate debt, the immensity of all the funds raised in 1984 is very apparent.