Interest rates continued to slide yesterday as the credit markets awaited some sign of whether the economy would revive from its sluggish first-quarter pace.
Yields on U.S. government notes and bonds dropped slightly in light trading, and the federal funds rate stood at about 7.75 percent, down from slightly over 8 percent a month ago. Money market rates fell as well, with Treasury bills closing at 6.95 percent compared with about 8 percent a month ago.
Meanwhile, the Veterans Administration said it will reduce the maximum rate on mortgage loans it will guarantee from 12 percent to 11.5 percent, effective today. Rates for conventional mortgages already have dropped about 2 percentage points from a year ago.
Many market analysts said they expect the prime rate, currently at 10 percent, to drop soon below the double-digit mark for the first time in seven years.
Federal Reserve Vice Chairman Preston Martin said in an interview with the Dow Jones news service yesterday that the falling cost of funds to banks makes a "clear case" for prime rate cuts "right away." But he said signs of a revival in bank credit demand could throw cold water on those prospects.
In an effort to prevent the economic expansion from ending, analysts said they expect the Federal Reserve Board to drop the discount rate again, to 7 percent from the 7.5 percent rate it set on May 17.
However, analysts said that the bond markets already have taken into account further easing by the Fed. "They've pretty much built in all the good news," said William N. Griggs, an owner of Griggs & Santow Inc. "The reality of a discount rate cut by the Fed wouldn't do much for this market."
Interest rates have declined in the past month because of the easing by the Fed. In addition, total private borrowing has been growing at a slower rate than last year because of weakness in economic activity. The markets are now looking toward the monthly employment report to be issued on Friday by the Labor Department to determine the direction interest rates will take, analysts said.
"After the surge in yesterday's trading session, rates have stabilized," said Elizabeth A. Ginste, assistant vice president of Dean Witter Reynolds Inc. "People are now sitting back and waiting for more economic data," such as the employment report.
Bond prices have moved higher in recent weeks as economic data pointed toward weak economic growth. The government estimated that gross national product grew at a 0.7 percent rate in the first quarter, down from a 4.3 percent rate in the fourth quarter of 1984, and new orders for factory goods have been weak for most of the year.
Industrial production has increased little since a year ago, and the unemployment rate has remained at 7.3 percent for the past three months. Many economists believe that the rate in May may have edged up, particularly with sluggish factory production and weak retail sales.
Business borrowing demand has not been dramatic, analysts said, leveling off in bank borrowing while increasing in commercial paper -- corporate IOUs sold in the money markets. The commercial paper rates are now about 2.5 percentage points below the benchmark prime rate of 10 percent.
Commercial and industrial bank loans declined slightly from mid-March to early May and appear to be turning up again, said Robert Ortner, Commerce Department chief economist. The slowdown in commercial and industrial borrowing is probably the result of a reduction in inventory accumulation, Ortner said.
Consumer borrowing is still strong. "Borrowing by the household sector from the commercial banking system has been vigorous thus far in 1985," according to Dean Witter.
However, in the last month, consumer confidence and buying plans plummeted as people became more concerned about current and future business conditions, according to the Conference Board.
Market participants expect the Fed to continue easing despite the rapid growth of M1, the closely watched monetary aggregate measuring the growth of currency and checking deposits. The aggregate has grown above its target rate all year and is expected to end the year above its target.
Tolerance of rapid growth in M1 "will permit both short- and long-term interest rates to decline steadily until late 1985, even as the economy shows signs of renewed expansion at midyear," according to Data Resources Inc. "The Federal Reserve's recent cuts in the discount and federal funds rates appear to be explicit signals that it will err on the side of ease rather than stringency until the recovery is thoroughly reestablished."
The markets also are looking toward a cut in the federal budget deficit to determine the future path of rates. Fed Chairman Paul A. Volcker has said that for each $50 billion in deficit reduction, interest rates could drop one percentage point.
The VA rate decline, the second in less than three weeks, saves about $25 on the monthly payment for the average federally backed loan of $64,000. In August 1984, the rate was 14 percent, representing a payment about $125 higher than it will be for mortgages beginning today. The last time VA loans were as low as 11.5 percent was early in June 1983.