WASHINGTON -- Pessimism over interest rates and the Federal Reserve's apparent inability to rein in the strong economy deepened yesterday, pushing the yield on the Treasury's long bond close to 8%.
The latest catalyst for the spreading gloom in the bond market, which spilled over into stocks, was the Commerce Department's report that factory orders in August surged 4.4%. The increase was the biggest since December 1992, and came on gains in most of the industries surveyed.
While some of the pickup in the factory sector reflected renewed production at auto assembly plants, orders outside the transportation sector jumped 2.4%. Shipments of factory goods advanced 4.5%, the largest increase in more than 15 years.
"People may finally be throwing in the towel and concluding that even with the interest rate hikes we've had to date, the economy continues to expand faster than the Fed would like and that further rate increases are in store over the balance of the year," said Brian Jones, an economist with Salomon Brothers Inc. "You certainly had a school out there that thought that the interest rate rtikes we've had to date would slow the economy, but so far there's no evidence of that," Jones said. In afternoon trading yesterday, the yield on the Treasury,s 30-year bond reached 7.96%, the highest level in about two and a half years. Analysts said there Was a good chance the yield would reach 8% by Friday, when the government is scheduled to release the September employment report.
Analysts have been expecting the Fed to raise short-term rates to 5.25% from 4.75% any time between Friday and the Nov. 15 meeting of the Federal Open Market Committee. But sentiment has also been building that additional tightening will follow, sending rates still higher in a strong economy with rising inflationary pressures.
"Interest rates have just not risen high enough to impact the economy," said David Lereah, chief economist for the Mortgage Bankers Association.
Lereah noted that the Fed did not abandon its policy of easy .money until last February, and that it can take up to a year or more for increases in interest rates to work their way fully into the economy. Homeowners with adjustable-rate mortgages, for example, wait until the anniversary date of their financing agreements to start paying higher rates.
"The economy is a big ship in a sea with a lot of momentum, and it takes a while to slow that thing down," Lereah said. "You just don't do it with a tugboat real quickly."
There is some evidence that higher rates are having an impact on the economy, but not much, analysts said. On Monday, for example, the Commerce Department reported that construction spending slipped in August for the first time in six months. Outlays by builders for single-family homes fell 1.2% to mark the third straight monthly decline.
But home buyers have been able to shield themselves by switching to adjustable-rate mortgages, which Lereah estimated now make up more than 40% of all loans.
Consumer purchases, which are normally sensitive to changes in interest rates and account for two-thirds of total U.S. output, have generally remained solid. On Tuesday, automakers reported August sales ran at a seasonally adjusted annual rate of 15 million, down only slightly from July and up 7.3% compared to a year earlier.
Analysts said car sales have been fueled by the increasing use of lease financing rather than traditional financing, enabling buyers to keep their monthly payments manageable although they do not end up owning the cars that they drive.
The mortgage bankers' group is looking for the Fed to push the federal funds rate up to 6.5% in 1995 and for longer-term rates to rise throughout the year. Lereah said he expects fixed-rate mortgages to climb close to 10% by the end of next year.
Still, not all analysts are pessimistic about rates ratcheting higher, although they continue to expect at least one more move by the Fed. Douglas Lee, chief economist for NatWest Washington Analysis, said recent statistics have been distorted as automakers rushed to production after their summer lull to retool for the new model year. At the same time, low inventories kept popular models out of the showrooms.
"The auto fluctuations are distorting the numbers and making the economy look a little stronger than it is," Lee said. He calculates that excluding autos, industrial; output slowed in the third quarter.
Other analysts agree that the economy is slowing down and that the Fed's rate increases will eventually take effect. "It's just a-matter of tuning," said Kevin Flanagan, an economist at Dean Witter Reynolds Inc. "The economy just hasn't quite caught up with the rising rate environment yet."
Economists surveyed by Technical Data expect the Labor Department to report an increase in nonfarm payrolls of around 250,000 in September. Thai would still be too rapid for a labor force growing on average about 200,000 per month, Lee said.
