The startling decline in interest rates this year has taken them to their lowest levels in eight years and set off a stampede of borrowers -- corporate and consumer -- trying to replace high-cost debt.
Like the plunge in oil prices, the interest-rate drop is expected to ripple throughout the economy, providing such benefits as lower inflation, increased business investment, more construction of single-family houses, stronger demand for large appliances and furniture, and a smaller federal budget deficit.
Not only are businesses taking advantage of lower rates by refinancing their debt, but some consumers are acting to lower their monthly mortgage payments and get extra cash to spend on more furniture and cars by refinancing their homes, economists said. The same is true of the U.S. Treasury, which will be able to roll over its debt at much lower rates and reduce the federal budget deficit.
Last week, yields on Treasury bonds approached the 8 percent level for the first time since April 1978, and corporate bonds flooded the bond markets in record amounts to take advantage of the low rates.
Rates on 20-year Treasury bonds fell from an average of more than 13 percent in the summer of 1984 to slightly over 10 percent in the fourth quarter of last year. The average interest rate on 3-month Treasury bills fell from 10.3 percent to 7.2 percent during the same period.
By the end of last week, rates on 20-year bonds were 8.35 percent, and three-month T bills were at 6.60 percent.
On Friday short-term rates, which generally had not joined in the decline, finally began to fall, as well. The Federal Reserve lowered its discount rate from 7.5 to 7 percent, causing a rush at banks across the country to drop prime lending rates from 9.5 to 9 percent. The drop in the prime rate will tend to bring down other short-term rates that tend to be linked to the prime, such as personal loans and some business loans, economists said. The rate cut also will help improve the general interest-rate climate, economists said.
The short-term-rate cuts are not expected to affect credit card rates, which are largely fixed. And they probably won't give a boost to automobile sales, as they usually do, because the major U.S. auto manufacturers have been offering cut-rate financing already, economists said.
"It may have a bigger impact on . . . car imports," said Michael Snow, senior vice president for Union Bank of Switzerland.
Domestic auto sales "will be fairly insulated," agreed David Jones, an economist for Aubrey G. Lanston. "We've already had these major sales promotions." The interest-rate impact will be seen mostly in "housing and durable goods that go with housing."
Some, but not all, Third World debtor nations will benefit from the prime-rate cut. Many of their debt reschedulings are tied to the more-market-directed London Interbank Offered Rate, however.
The interest-rate decline also will reduce the costs of banks and other businesses in attracting money by reducing rates on certificates of deposit and commercial paper. At the same time, it will reduce investment income for people buying those debt instruments.
"I think that, to the extent that the prime tends to serve as a sort of benchmark rate against which other rates are set by a bank, it will tend to bring down lending rates to a lot of people for loans that banks extend on a negotiated basis," said William N. Griggs of Griggs and Santow Inc. "It doesn't represent a rate at which prime customers can borrow. It does set a base rate."
The decline in long-term rates is encouraging business investment, said Douglas Cliggott, economist for the Conference Board in New York. Not only do businesses find it cheaper to borrow, but also companies that have spare cash find capital investment makes more sense than parking it in financial investments, Cliggott said.
"I am marking up my capital-investment forecast for 1986 because of energy declines and interest-rate declines . . . and the fear of tax reform," which is causing many companies to speed up purchases, said Jerry Jasinowski, chief economist for the National Association of Manufacturers.
"Businesses do a considerable amount of investing out of cash flow, but I do think firms are moving toward increasing their leverage" because of lower interest rates, Jasinowski said. "With interest rates coming down, they will finance new spending with debt."
Falling oil prices have raised economists' expectations of improved economic growth this year. And the prospect that falling oil prices will help push inflation lower also made long-term assets more attractive, bidding up the prices of bonds and reducing their yields.
Another major influence on rates has been the belief that the Gramm-Rudman-Hollings deficit-reduction law will reduce the federal budget deficit significantly, which would lessen pressure on credit markets by the federal government. Other factors are efforts by the United States and four allies to push down the dollar, and the general slackness in the economy.
"The containment of inflation, combined with growing confidence that the federal deficit will be brought down significantly, has contributed to a sharp drop in the inflation premium in long-term interest rates," economist Alan Greenspan said in his latest report to clients. "At the same time, the Fed's highly accommodative stance has encouraged the markets to assume that monetary policy would not push rates up again."
One borrower sure to benefit in a big way from a sustained decline in interest rates is the federal government. According to the 1987 budget, a one-percentage-point decline in interest rates from administration projections starting last fall would reduce net interest costs by $5.1 billion this year and by as much as $15 billion by 1990.
The administration forecast three-month Treasury bill rates of 7.3 percent this year and 10-year Treasury notes of 8.9 percent. Already, rates for both instruments have fallen at least half a percentage point below administration estimates.
The T-bill rate was 6.60 percent Friday, and the 10-year note was trading at 7.96 percent.
Another area that is generally expected to do well as interest rates decline is housing. However, other economic factors will offset the benefits of lower interest rates, said Michael Sumichrast, chief economist for the National Association of Home Builders.
"Single-family housing is going to do very well," Sumichrast said. "Multifamily is the problem."
The latest monthly figures showed sales of new one-family houses rose 4.4 percent in January to the highest level in two years, urged on by falling mortgage rates, the Commerce Department reported last week.
Additionally, "We have some sick cities and sick states" due to problems in the agricultural and oil sectors, Sumichrast said. The South, where the pain from lower oil prices is being felt, has accounted for 5.5 of every 10 housing starts in the country. "Can the Northeast make up for that?" Sumichrast asked. "Heck, no."
But he still expects that for every one-percentage-point decline in mortgage interest rates, 1.5 million more households will be able to qualify for a typical house, which now averages $108,600.
Fixed-rate mortgages have fallen from about 13 percent a year ago to 11.34 percent last month, according to the Federal Home Loan Bank Board. In some parts of the country, mortgages with a 25 percent down payment are as low as 10 percent. Adjustable-rate mortgages with caps dropped from 10.13 percent to 10.06 percent between January and February, the bank board said.
Corporations also will reap benefits from the interest-rate decline. Many corporations, saddled with debt at higher interest rates, are borrowing at the new lower rates and paying off old debts, economists said. Corporations issued $5.1 billion in new debt last week and $7.4 billion the previous week, according to Salomon Brothers.
In addition to paying old debt with new borrowing, many businesses are buying new equipment and modernizing, economists said.
The lower rates also have an indirect effect on investment by increasing the demand for products, particularly goods which last a long time and would be in line for longer-term financing, the Conference Board's Cliggott said. This demand fuels the need for higher investment by business, Cliggott said.
The Conference Board conducts a regular survey of planned business spending. "The preliminary results indicate an upward revision in planned expenditures for 1986," Cliggott said. He said other factors such as the falling dollar also would help new investment.
So far, economists see few storm clouds on the horizon. Although rates are not expected to fall as sharply as they have in the past several weeks, they are expected to remain weak through the rest of the year.
Merrill Lynch said in its most recent economic report that the outlook for interest rates depends on oil prices. Many economists have said that the recent plunge in oil prices is only temporary; if oil prices rise again, it would mark "the end of the current bond market rally," Merrill Lynch said.
Greenspan said that interest rates will "firm modestly" late this year and early in 1987 before starting downward again. Greenspan added that as the dollar continues to slide "some increase in rates is likely to be necessary in order to attract the funds needed to cover the balance-of-payments deficit and our domestic credit requirements."
Additionally, as the economy expands, the Fed will tend to let rates rise, and later this year, the financial markets may decide that achieving the Gramm-Rudman-Hollings budget cuts will be harder than expected, leading to higher interest rates, Greenspan said.