(May 9) – “The cost of financing is on the rise for consumers and companies. The benchmark fixed-interest rate on 30-year home mortgages, at 8.65%, is the highest since early 1995, and the yields on junk bonds, at an average of 12.79%, are well above their levels then. Corporate bond yields, at 8.89%, are also approaching early 1995 marks,” writes Jonathan Fuerbringer in today’s New York Times.
“These are all signs that the Federal Reserve’s interest rate increases, five moves of a quarter-point since last June, are beginning to have an impact on the financial markets.
But the higher rates have not yet led to a significant drag on the overall economy, in part because market rates have risen to their five-year highs very recently and in part because stocks have been strong enough that consumers have not been discouraged. Although growth has slowed somewhat since the fourth quarter of 1999, the economy grew at a 5.4% annual rate in the first quarter of 2000. And in the most significant data since then, 340,000 jobs were created last month as the unemployment rate fell to a 30-year low of 3.9%, the government said on Friday.
“This lack of bite in monetary policy, even more than recent suggestions of some inflationary pressure in wages, has led many analysts to predict that the Fed will push up its target for short-term interest rates much further then the current 6 percent before the economy will slow to an acceptable pace. With Fed policy makers scheduled to meet next Tuesday, the debate has shifted to whether they will raise their target rate by half a percentage point instead of the familiar quarter-point steps.
“A recent rise in the yield on the futures contract of federal funds shows that many investors expect the central bank’s target rate to be 7% by November.
The Fed has moved cautiously until now partly because it saw few signs of inflationary pressure other than the spurt in crude oil and gasoline prices.
“Laurence H. Meyer, a Fed governor, said in a speech last month that ‘the current episode is the smallest and most gradual tightening’ since the late 1960’s. ‘So the modest effects on aggregate demand to date,” he said, “perhaps only confirm the relatively modest and extremely gradual nature of the current tightening.’ In addition, Mr. Meyer said, ‘some developments suggest that the recent policy moves may have had a more limited effect on aggregate demand than would have been expected.’
“To measure the impact of monetary policy, one has to look at what effect a rise in the federal funds rate, which is the rate on overnight loans between banks, has on broader financial conditions including interest rates, stock prices and the dollar’s exchange rate. Mr. Meyer said one gauge, the Goldman Sachs financial conditions index, ‘is not only at the very low end of historical experience, but is nearly unchanged’ since June.”