Interest Rates During Economic Expansion · Interest Rates during Economic Expansion INTEREST RATES, after declining during the mild recession in economic activity from mid-1953 to

Interest Rates during Economic Expansion

INTEREST RATES, after declining duringthe mild recession in economic activity frommid-1953 to the summer of 1954, began tofirm in the fall of 1954, and have since ad-vanced persistently over the period of busi-ness recovery and expansion. The advancegathered momentum during 1955, and in1956 has carried most rates above their1953 peaks.

Rising levels of demand for goods haveactivated rising demands for credit and capi-tal to finance their purchase, while savingsand other funds available to supply these en-larged demands have grown less rapidly.Federal Reserve policy has limited additionsto bank reserves to amounts consistent withthe needs of orderly economic growth.

Short-term interest rates, which experi-enced the greatest declines under the re-duced credit demands of the 1953-54 reces-sion, showed the sharpest advances whendemand pressures subsequently strength-ened, as the chart shows. Long-term ratesrose to some extent during 1955, butmoved up more sharply in 1956 when en-larged plant and equipment expenditureprograms increased business demands forinvestment funds. Due to the slower paceof long-term rate increases, spreads betweeninterest rates within the maturity structurebecame the narrowest since the early 1930's.

Differences in amplitude of movementare characteristic of short- and long-terminterest rates, for even small movementsin long-term rates represent relatively largerprice changes, and these in turn exert a sig-nificant value effect on security portfolios.

SELECTED INTEREST RATES

U.S. GOVT.LONG-TERM

\ I F R. DISCOUNT J> " " I RATE | /

* * \ / * - • / TREASURY BILLS

V

/ V-^CORPORATE Aaa ^_s"^*~

COMMERCIALPAPER

2.0

4.0

3.0

2.0

1.01953 1954 1955 1956

NOTE.—Monthly averages. See subscripts of subsequentcharts for details concerning series. Long-term U. S. Govt.is the old series. Latest data are for August.

The stability of long-term rates relative toshort-term rates since mid-195 3 has also re-flected the fact that demands for long-termfunds continued to rise during 1954 despitethe recession, whereas demand and supplyrelationships in short-term markets changedsharply in that period, as business loan de-mand declined and supply conditions eased.

The flexibility of interest rates in recentyears and the relationship between short-and long-term rates are more similar to in-terest rate behavior in this country prior tothe 1930's than in the intervening period,

927

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

September 1956

928 FEDERAL RESERVE BULLETIN • SEPTEMBER 1956

LONG- AND SHORT-TERM INTEREST RATESPer cent

*

\ II

/ V tJ- "—V

1 , , ,

PRIME COMMERCIAL1 4-6 MONTHS

/i A

' \ ̂ '\1 ^ A A1 s V * \ *. * *

/ v V \—^ -̂̂ _—-̂ —^ N > <- '

HIGH-GRADERAILROAD BONDS

!

PAPER »

/ \

/ ^

, , , 1,

.A

\

i i i 1 i

\>

\

\

—

V CORPORATE Aao

1880 1690 1910 1920 1930 1940 1950

- 4

2

1960

NOTE.—Annual averages. For 1880-1931, bond yields are theMacauley unadjusted high-grade railroad series (National Bu-reau of Economic Research); beginning 1932, Moody's cor-

which was dominated by conditions arisingfrom a major depression and a world war.This is shown by the accompanying chart.

It will be noted from the chart that theascending pattern of interest rates fromshort- to long-term that was characteristicof the past quarter of a century did not gen-erally prevail in earlier periods. Prior tothe 1920's short-term rates, which weremostly affected by domestic factors of strongdemand for and limited availability of lend-able funds in these areas, were usually higherthan yields on high-grade bonds, which weremore largely affected by international capi-tal market developments. Short-term ratesfluctuated more widely in response tochanges in general business conditions andthe state of the money market. During the1920's, short-term rates were generally be-low long-term bond yields but rose abovethem in periods of credit stringency.

PATTERN OF THE ADVANCE

Yields in the market for United States Gov-ernment securities have been particularlysensitive over the past two years to changesin the supply of and demand for credit andcapital. This responsiveness reflects the

porate Aaa composite series. Data for 1956 are averages forJanuary-August.

important role of Government securities inthe portfolios of institutional investors andthe use of such securities to adjust moneyand investment positions. Interest rates inother securities markets have typicallymoved with yields on Government securi-ties, but with varying degrees of correspond-ence. The over-all similarity of rate move-ments for different types of short- and long-term debt is shown in the chart on page 927.

For loan instruments which involve animportant customer relationship as well asvariable contract terms such as repaymentson a prescheduled basis, the similarity ofrate movement has been less marked.Among these, the rate on prime short-termloans to business at leading city banks andthe yield on discounted Federal HousingAdministration mortgages have followedchanges in market rates with some lag.

Over the period of advance from August1954 to September 1956, the yield on thelongest term United States Governmentbonds rose from 2.61 to 3.25 per cent andthat on high-grade corporate bonds from2.87 to 3.53 per cent. Gains in most bondyields were only slightly greater than theirrecession losses. In the same period the


September 1956

INTEREST RATES DURING ECONOMIC EXPANSION 929

yield on Treasury bills rose from around1.00 to about 2.70 per cent, after havingincreased nearly .40 of a percentage pointfrom mid-June through August 1954. Overthe full period of advance, the gain in thebill yield exceeded its recession loss by about.40 of a percentage point. The accompany-ing table compares interest rate advances inthe past two years with earlier recession de-clines for selected types of public and privatedebt.

CHANGES IN INTEREST RATESSELECTED PERIODS, 1953 TO 1956

[In per cent per annum]

Maturity grouping andtype of rate

Short-term

U. S. Treasury billsPrime commercial paper..Finance company paper..Bankers' acceptancesPrime loans, leading banks.F. R. discount (N. Y.)

Intermediate-term issues

U. S. Govt.,3-5yr

Aaa State Govt., 10 yr...

Long-term bonds

U.S. Govt.:Old seriesNew series

Aaa corporateBaa corporateAaa State and local govt...

Rate,week

endingSeptem-ber 8,1956

2.683.503.132.884.003.00

3.492.49

3.223.253.534.012.62

Advance

(+August1954 toSeptem-ber

+ 1+2+ 1+ 1+ 1+ 1

+ 1+ 1

+

-j-_j_-\-+

1956

.69

.19

.88

.63

.00

.50

.75

.10

.73

.64

.66

.54

.72

Decline(-),

mid-1953peak toAugust

1954

- 1 281.441.25

.63

.25

.50

-1.35- .90

.66

.70

.55

.42

.83

NOTE.—Changes in rates are based on figures for the follow-ing dates: for September 1956, on averages for the week endingSept. 8; for August 1954, on averages for the week ending Aug.28, when most of the series shown (excluding Treasury bills and3-5 year Govt. issues), were close to their 1954 lows; for mid-1953 peaks—U. S. Govt. securities, week ending June 6; 10-yearState and Aaa corporate issues, week ending June 20; and AaaState and local and Baa corporate, week ending June 27. Rateson commercial paper (4-6 mo.), directly placed finance com-pany paper (3-6 mo.), bankers' acceptances (90 days), primeloans (leading city banks), and F. R. discounts and advanceshad already reached their 1953 highs by the week of June 6 andare calculated from that date.

Figures for 10-year State govt. issues and for long-term corpo-rate and State and local govt. bonds are based on data fromMoody's Investors Service. For description of U. S. Govt.series, see subscript of chart on page 931.

FACTORS UNDERLYING RATE INCREASES

General advances in interest rates after late1954 reflected a growth in total privatedebt and equity financing that was larger in1955 than in any previous year. Majorincreases in financing occurred in the busi-ness and consumer sectors (including homemortgage borrowing), and net new financingin these sectors during 1955 totaled about$37 billion, nearly double the increase in1954. Net borrowing by governments—Federal, State, and local—was smaller in1955 than in 1954.

During 1956 business demands in bothcapital and credit markets have risen sub-stantially further. State and local govern-ment borrowing has been maintained, whilethe increase in short- and intermediate-termborrowing by consumers has leveled off.Although funds borrowed for residentialconstruction needs have fallen somewhat,total financing requirements for constructionactivities have remained high. The FederalGovernment retired debt over the fiscal yearending June 1956.

Expansion in demands for long- andshort-term credit has not been accompaniedby a corresponding increase in the supplyof savings, which must be relied upon tomeet the bulk of credit demands. Likewise,the ability of the commercial banking systemto expand its loans and investments has beenlimited.

As economic conditions changed aftermid-1954, Federal Reserve credit policyshifted, moving gradually, with some interimrelaxation, from a position of ease in 1954to restraint of inflationary pressures in thelatter part of 1955 and in 1956. Reflectingthe impact of growing credit demands andlimitations on the amount of reserves sup-plied through Federal Reserve open marketoperations, a growing number of member


September 1956


banks turned to the discount facilities of theFederal Reserve Banks for temporary bor-rowing of needed reserve funds. Temporaryborrowing by member banks, which totaledonly about $100 million in the fall of 1954,has ranged between $600 million and $1billion most of the time since mid-1955.Reinforcing the restraint exerted by in-creased member bank borrowing and fol-lowing advances in market rates of interest,discount rates at Federal Reserve Bankswere raised from W2 per cent in early 1955to a current rate of 3 per cent.

Faced with limitations on the supply ofreserves and generally maintaining their tra-ditional reluctance to incur continuing in-debtedness to the Reserve Banks, memberbanks sold United States Government secu-rities heavily in order to meet the sharplyexpanded demand for loans. These salesdepressed prices, thereby increasing yieldsto levels that attracted nonbank purchases.

Since the fall of 1955, the rise in interestrates has been interrupted by several tempo-rary declines, as may be seen in the charts.These short-run fluctuations were moreprominent in yields on Government secu-rities than in those on private debt. Theyreflected various factors, including changesin the emphasis with which open marketoperations were utilized by the Federal Re-serve System to effectuate its general policiesof restraint, as well as shifts in short- andlong-term credit demand, changes in thesupply-demand relationship of liquidity in-struments such as Treasury bills, uncertain-ties in financial markets as to business trends,and varying market expectations as to thefuture course of interest rates.

U. S. GOVERNMENT SECURITIES

Since early 1951, yields on United StatesGovernment securities have been more re-

sponsive than most other rates to changesand expected changes in economic activityand credit conditions. As the accompany-ing chart indicates, Treasury bill yields havemoved over a range of nearly 2V\ percent-age points since mid-1954. The same gen-eral pattern of changes has been reflectedthroughout the Government security mar-ket but with progressively smaller fluctua-tions the longer the maturity. Long-termyields have advanced about % of a percent-age point.

In late 1955 and 1956, rates on short-term Government securities have been atthe highest levels, and spreads within thetotal structure of Treasury yields at theirnarrowest, since the early 1930's. The re-cent rapid advance in yields on long-termTreasury bonds has carried issues due orcallable in 10 to 20 years to record highs.

The marked rise of short-term Treasuryyields from 1954 to 1956 and the resultantnarrowing of yield spreads are illustratedby the lower section of the chart, whichshows the yield structure in 1954, near thestart of the advance, and for a recent date.This provides a specific comparison of thelevel and pattern of Treasury yields betweenthe two dates. Of particular interest is thefact that the yield on 3-5 year maturities hasmoved from a level considerably below toone above the yield on long-term bonds, re-sulting in a bulge in the intermediate-termmaturity range of the yield pattern. Yieldson 3-5 year issues recently reached a levelclose to 3.50 per cent.

The background of recent changes inthe level and structure of Treasury yieldswas established during the period of interestrate declines from June 1953 to the summerof 1954. As credit demands from businessesand consumers slowed during that period,borrowing at banks by sales finance com-


September 1956


YIELDS ON U. S. GOVERNMENT SECURITIES

- 3

2 3 i i 6 7 6 S 10 11 12 13 U15 16 17 19 19 20 21 2223 24Yeors to first call or maturity

NOTE.—Upper section—New series represents 3(4 per centbonds of 1978-83, May 1953-February 1955, and, beginningFebruary 1955, also the 3 per cent bonds of 1995; old seriesrepresents taxable 2V4 per cent bonds due or callable after 12years, January 1953-September 1955; thereafter, taxable bondsdue or callable in 10-20 years. Issues of 3-5 years are selectednotes and bonds. Treasury bills are market yields on 90-dayissues. Latest data are for week ending September 8.

Lower section—Curves are based on closing bid yields formarketable, fully taxable Treasury issues, as compiled by theFederal Reserve Bank of New York. Yields are to maturity,except that callable bonds, which were selling above par onAug. 26, 1954, are to first call on that date.

panies and other businesses declined morethan $1 billion, and total loans at commer-cial banks rose less than $2 billion. Easingof bank reserve positions, however, stimu-lated an expansion of investments in Govern-ment securities by nearly $9 billion, raisingtotal bank loans and investments by morethan $11 billion.

Banks lengthened the maturity of their

Government security holdings in this period,both adding to portfolios of intermediate-and long-term issues and reducing holdingsof short-term issues. This shift, which cameat a time of declining bank earnings, wasencouraged by the general improvement ofbank reserve and liquidity positions, and byadvancing Government security prices.

Bank acquisitions of longer term securi-ties were also encouraged by a sizable in-crease in the supply of intermediate-termTreasury issues arising from large new of-ferings in cash and refunding operations.From June 1953 to August 1954 market-able Federal debt rose nearly $7 billion.Within the debt structure the1 supply of mar-ketable securities in the 1-10 year maturityrange rose more than $11 billion, while thesupply of issues maturing within one yeardeclined nearly $5 billion. Over the sameperiod commercial bank holdings of 1-10year maturities increased about $10 billion,and their holdings maturing within one yeardeclined more than $2 billion. Commercialbanks not only subscribed directly to newTreasury issues but were also buyers of otherintermediate-term securities in the second-ary market from nonbank investors.

Business loans of commercial banks be-gan to expand rapidly in late 1954, andfrom October 1954 through June 1956total loans rose nearly $20 billion. WithFederal Reserve policy limiting increases inbank reserves, total loans and investmentsof commercial banks increased only $6 bil-lion. The bulk of the huge loan expansionwas thus financed through bank sales ofGovernment securities. Bank holdings ofmarketable Federal debt declined nearly$13 billion from October 1954 throughJune 1956, while the over-all supply of suchFederal debt was reduced only $3 billion.


September 1956


Approximately $11.5 billion of the re-duction in bank holdings of Government se-curities was issues maturing within oneyear, most of which represented outrightsales. Despite an active demand from non-bank investors, these sales placed steady up-ward pressure on short-term market yields.

Bank liquidation of Treasury issues to fi-nance loan expansion during 1955 tendedto spill over into intermediate maturities asholdings of short-term issues were reduced.Selling in this maturity range was initiallyconcentrated in Treasury notes, but ascredit demand continued, liquidation alsospread to Treasury bonds, particularly thenew issues in which bank purchases had beenheaviest during late 1953 and 1954. Asbanks extended their liquidation to inter-mediate maturities, they encountered greatermarket resistance, and yields were markedup sharply.

PRIVATE SHORT-TERM RATES

Interest rates on private short-term openmarket paper have moved in general cor-respondence with yields on short-termUnited States Government securities during1955 and 1956. Treasury yields have typi-cally moved first, partly because short-termGovernment securities are the major typeof security used by banks and other investorsto adjust money and liquidity positions, butalso because such yields are set by activetrading in a highly organized and sensitivemarket.

As Treasury yields rose during 1955 and1956, dealers and other sellers of privatepaper had to distribute the supply of suchpaper in competition with increasingly at-tractive yields on Federal debt. To keepinventories moving, rates were adjusted up-ward. Within this pattern of advance, deal-ers' inventories of commercial paper and

bankers' acceptances accumulated periodi-cally, as the flow of offerings from borrowersexpanded. At such times advances in rateswere accelerated. With new car sales in1955 at record highs, the supply of directlyplaced finance company paper was likewiseheavy.

Among the different types of private pa-per, rates on commercial paper led muchof the 1955 advance, followed by directlyplaced finance company paper and bankers'acceptances, in that order. Most changeswere Vs of a percentage point. During1956 no particular lead-and-lag pattern hasbeen apparent among these rates; each typehas led some of the changes, and other typeshave usually followed within a matter ofdays. Changes this year have included tem-porary declines as well as further advances,reflecting wider fluctuations in Treasury billyields.

Over the full period of advance, the rateon 4-6 month prime commercial paper rosenearly 2VA percentage points (about thesame as the increase on 90-day Treasurybills from the June 1954 low). The rateon 3-6 month finance company paper ad-vanced 1% percentage points, and the rateon 90-day bankers' acceptances \5/s per-centage points. Early in September 1956the rate on commercial paper was 3Vi percent, on finance company paper, 3Vs percent, and on bankers' acceptances, 2% percent; the yield on Treasury bills was about234 per cent.

In 1955, when all short-term rates wereadvancing steadily, the more rapid responseof Treasury bill yields had the effect ofnarrowing spreads between bill yields andprivate rates. During periods of temporarydecline in bill yields this year, spreads withinthe complex of short-term rates widened.

Since 1954 the discount rate at the Fed-


September 1956


eral Reserve Bank of New York has beenraised six times by VA of a percentage point,and discount rates at other Reserve Bankshave for the most part shown similarchanges. Although discount rate changessince 1954 have typically followed advancesin other short-term rates, increases in the lat-ter have partly reflected money market ex-pectations that discount rate changes werein prospect.

One of the most sensitive indicators ofday-to-day conditions in the money markethas been the rate on surplus member bankreserve deposits at Federal Reserve Banks.These deposits, known as Federal funds, aretraded on an immediately available basis tomake prompt and strictly temporary adjust-ments in bank reserve positions.

Since in recent years the yield on Treas-ury bills has at times diverged from othermoney market rates under the impact ofdominant temporary demands from non-bank investors, the Federal funds rate hasfrequently been a more accurate measureof money market tightness than Treasurybill yields. Under the easy money condi-tions of late 1954, the Federal funds ratewas typically below the Federal Reservediscount rate; recently, as credit conditionshave tightened, the funds rate has beenmostly at the discount rate, its usual ceiling.

As is typical of loan contracts that in-volve an important customer relationship,the rate charged by leading city banks onprime loans to business lagged behindchanges in open market rates both in the1953-54 decline and in the subsequent ad-vance. The chart indicates the extent ofthe lag. In evaluating the economic signi-ficance of the lag, it should be noted thatthe interest rate is only one dimension ofbank lending. The general availability ofloan funds, the amount of credit available

SHORT-TERM INTEREST RATESPer cant

1953 1954 1955 1956

NOTE.—Weekly average rates for prime bank loans to busi-ness at leading city banks; prime open market commercialpaper, 4-6 mo.; directly placed finance company paper, 3-6 mo.;prime bankers' acceptances, 90 days; discount rate at F. R.Bank of New York. Yields on Treasury bills are market yieldson 90-day issues. Latest data are for week ending Sept. 8.

on individual loans, and the classificationof loans as prime or other are all likely tovary ahead of the interest rate itself.

BOND YIELDS

Over the past two years, markets for corpo-rate and for State and local governmentbonds have been subjected to generally con-tinuing pressures. Although an increasingproportion of corporate long-term borrow-ing has been effected through direct place-ment of security issues with institutionallenders, the volume of public marketings hasbeen large during most of the period. Stateand local government issues, which are usu-ally marketed publicly, have been in some-what smaller volume in 1955 and 1956 thanin 1954. However, commercial banks, cus-tomarily large buyers of the latter issues,have reduced their purchases over the pe-riod, thereby contributing to the pressure onsecurity markets.

The cost of market borrowing by corpo-


September 1956


rations and State and local governments hasrisen considerably, with much of the increaseoccurring in 1956. There have been somefluctuations around the upward trend inyields, reflecting sharp but temporary varia-tions in the volume of public offerings ofsecurities. The rate of advance in yieldsover the period, and the timing and extentof temporary declines, have varied amongobligations of different issuers and differentrisks.

IONDPer cent

YIELDS

\ s i A T l 4

* . ,

CORPORATE Sao

LOCAL GOVT Aco_A 20 years

Kj-s* •'STATE

*-_« • * - " 10 yea

1

U. S. GOVTtONG-TtRM /

1953 19S4 1955 1956

NOTE.—Corporate and State and local govt. series are fromMoody's Investors Service. U. S. Govt. and corporate yieldsare weekly averages of dally figures; State and local govt.yields, Thursday figures. Latest data are for week endingSept. 8.

Reflecting the intensity of business financ-ing requirements, yields on corporate se-curities have shown the narrowest fluctua-tions. Yields on high-grade corporatebonds have tended to stabilize when yieldson long-term United States Government se-curities declined, and lower grade corpo-rate issues have shown little response toshort-run fluctuations in Government se-curities. Despite differences in short-runmovements, however, increases in yields onhigh-grade corporate bonds over the two-year period have been about the same as forthe longest term Governments, and those on

lower grade issues have been only slightlysmaller. Yields on State and local govern-ment securities have advanced somewhatmore than those on either United StatesGovernment or corporate bonds.

Corporate high-grade bond yields arecurrently near 3.50 per cent, a postwar high,and high-grade State and local governmentyields, at 2.60 per cent, are only slightlybelow their mid-1953 peak. The rise inhigh-grade corporate yields since late 1954has been less than one-third that in the rateon short-term commercial paper, and theadvance in yields on long-term State andlocal bonds has been about two-thirds thaton intermediate maturities. In June 1956the rate on commercial paper rose aboveyields on outstanding high-grade corporatebonds.

In 1954 reoffering yields on new issues ofhigh-grade corporate securities were aboutthe same as those on outstanding issues ofsimilar quality. Under pressure of heavynew offerings in 1956, however, the spreadbetween the two has widened to nearly Viof a percentage point, carrying reofferingyields to 4.00 per cent or higher. The lagin yields on outstanding bonds behind thoseon new issues is attributable mainly to thelack of trading characteristic of secondarymarkets in corporate and State and localgovernment bonds.

REAL ESTATE MORTGAGES

Demand for real estate credit has been un-usually strong throughout the postwar pe-riod. Demand for such credit was particu-larly heavy during the 1953-54 recession,and in fact began to expand sharply at thebeginning of 1954. Despite the larger vol-ume of credit demanded, mortgage marketscontinued to ease until the end of that year.At that time the continued heavy demand


September 1956


for mortgage credit began to encounter alessened availability of funds from banks,as other types of loans began to expandrapidly. The general rise in interest rateswas consequently also reflected in higherrates on mortgages.

New mortgage lending rose further in1955, as nonbank investors continued toincrease mortgage loans, partly through thetaking up of prior commitments. At mid-1955 new lending was at the record monthlyrate of $2.4 billion compared with $1.6 bil-lion at the end of 1953. So far in 1956new lending has continued large at a levelof about $2.3 billion a month.

Changing yields on conventional mort-gages are reflected mainly by changes in in-terest rates, fees, and other charges and bychanges in maturities and in loan-to-valueratios. In the recent period interest rateson conventional loans have risen, and theproportion of all mortgage lending made onsuch mortgages has increased.

Federally underwritten mortgages differfrom competing investments in that they arerestricted by law or regulation to a maxi-mum rate of interest. In practice this ratehas become the actual rate, and the align-ment of yields on such loans with yields onalternative investments has taken placethrough a discounting process at the timeof origination or when mortgages aretraded in the secondary market.

In a period of rising returns on invest-ment, the flexibility of the discounting proc-ess is limited, however, because sellers andbuilders are reluctant to absorb the dis-counts themselves and are prohibited frompassing more than one percentage point ofthe discount directly on to house buyers.As a result, yield changes on Federally un-derwritten mortgages have been more slug-gish than interest rate changes on conven-tional mortgages and other types of securi-ties. Also during periods of generally ris-ing interest rates, investment funds havetended to be diverted to some degree fromFHA and VA mortgages to higher yieldingalternatives.

To derive approximate yields from dataon typical prices at which 4V£ per cent FHAhome mortgages are sold, it is necessary tomake certain assumptions as to average ex-pected maturity. Currently, yields so de-rived are at about the 1953 high and aboutVi of a percentage point above their low inthe last half of 1954. Since late 1954, theseyields have apparently moved similarly to—but with a lag of several months behind—other long-term interest rates. This lagreflects in part the fact that prices reportedon Federally underwritten mortgages in thesecondary market at any one time are basedon terms agreed upon several months aheadof the transaction, as well as on currentprices of spot transactions.


September 1956

Interest Rates During Economic Expansion · Interest Rates during Economic Expansion INTEREST RATES, after declining during the mild recession in economic activity from mid-1953 to

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