Interest rates are on the rise

Real Estate Weekly, May 22, 1996 by David X. Stumpf

The yields on the 30-year Treasury Bonds began to turnaround in mid-February, right on the heels of the Federal Reserves last cut of a quarter percent in short term rates. Since that cut in late January, the 30 year T-Bond yields have gone from 6.09 percent on February 9th, to 7.11 percent on May 3rd. Some investors use 7 percent yields on the long-term bonds as the benchmark for switching from stock to bonds. The 7 percent mark, however, has not held it's ground thus far. The bond market rallied again on May 13, bringing the long-term bonds back down to 6.89 percent.

Signs of Strong Economic Growth

Strong labor reports in both February and March has sent bond yields to a seven-month high in early April. Unemployment is down to around 5.5 percent, with a large increase in new jobs. Wages rose by 1 percent in the first quarter, the fastest pace in five years. Consumer confidence is also up as evidenced by strong domestic auto sales. New factory orders showed unexpected strength in March despite weak new home sales. In fact, most leading economic indicators were up over the last two months.

However, the strong growth economy raises concerns of impending inflation. On May 2nd, data released by the Commerce Department indeed showed signs of a healthy economy that had revived from the bad weather doldrums at the start of the year. However, Wall Street responded to the good news with nearly a 77 point drop in the Dow Jones and bond yields rose above 7 percent for the first time in over a year.

This follows another very loud thud which occurred in early March when the Dow dropped 171 points (the largest drop since 1991), also on the heels of the news that economic growth was the highest in two and a half years.

This year is fast turning out to be another tumultuous year on Wall Street. The Stock Market began the year with a continuation of last years relentless pace of new records for the Dow Jones. The Dow, after breaking through the 5,000 mark in late November, climbed to above 5,600 in early April before again losing ground over the next several weeks. The NASDAQ composite index also set a string of new records in late April through early May of this year.

Mutual Funds Dominating Financial Markets

On the brighter side, the huge swings in the financial markets have come as a test of the resolve of small mutual fund investors to persevere in the stock market without panicking at every twist and turn. Strong earnings and low inflation have helped to sustain public confidence in Wall Street. Mutual funds continued to show an influx of cash as investors put $118 million in funds in 1995, surpassing records set in 1993. Currently, over a trillion dollars of domestic capital is invested in American stocks, replacing real estate and bank deposits as the largest segment of US investment. The Bull Market, which began in 1988, has now gone into its eighth year. The longest previous stretch was six years, following the 1929 crash. However, we still will have to wait to see what lies ahead for the markets.

Fears of Inflation

There also seems to be growing concern of rising inflation. Corn and wheat prices hit a 15-year high in mid-February. Crude oil prices have also hit a three-year high, causing gasoline prices to rise at the gas pumps. Just the mere mention of rising oil prices must send shockwaves through the financial markets. One cannot forget the 70s, when a combination of low unemployment and stagnant growth coupled with rising prices caused "stagflation." Hopefully, the rise in oil prices may be short-lived, once Iraq is allowed to re-enter the market place.

The dollar has been bolstered since last year's slump and is now again a favorite with overseas investors, whose own economies are showing greater signs of weakness. Exports of US services and goods are up. The fact of the matter is that the US economy in fairing far better than most of the other overseas markets. Europe is experiencing a wave of unrest due to high unemployment. The reunification of Germany has caused near record unemployment. There is widespread dissatisfaction in France and England, where inflation and diminishing wages are causing protests and strikes. In Asia, the Japanese economy has only now begun to emerge from its recession. US export of cars to Japan are up since the passing of new trade agreements.

It's A Low Inflation Slow Growth Economy

Alan Greenspan testified back in February that the economy was basically on the right track and subsequently, The New York Times reported on March 28th that Mr. Meyer of the Federal Reserve Board testified at a Senate hearing that "The single most important thing in the long run is protecting the value of the dollar, price stability and containing inflation." Since the Feds previously cut rates last January bringing prime to 8.25 percent, the Federal Open Market Committee has opted to pass on further rate cuts and they continue to show extreme caution in easing credit. The Feds have made inflation a paramount concern and they are not likely to hesitate in raising rates again, if there are signs of strong growth in the economy. The Feds next FOMC meeting was scheduled for May 21, but it is still too early to predict how they will react to reports of strong growth and higher oil prices. However, inflation still seems to be under control for the fifth consecutive year.