The economy may be surprisingly strong right now, with interest rates rising, but bankers should plan for lower rates by next spring, according to the latest American Banker yield and rate survey.
Only three of 10 economists in the survey said they expect the prime lending rate at the end of 1997's first quarter to be higher than the current 8.25%, while several say they feel it could be as much as half a point lower by next March 31.
Most economists polled also say they think other rates, ranging from those on shorter-term securities to rates for mortgages and the Treasury long bond, will drift lower as the economy loses altitude beginning in the second half of this year.
The recent vigor of business conditions and glimmers of inflation have jolted Wall Street. Last week's report of 2.8% economic growth in the first quarter prompted bond investors to push the long bond's yield above 7% - up from 6% in late January.
Rates retreated a bit after Friday's weaker-than-expected employment report for April - only 2,000 jobs were created versus the market's expectation of 119,000. Still, job growth for the year to date has been brisk, averaging 166,000 per month.
David Orr, capital markets economist at First Union Corp., said the recent rise in rates is not well founded. The bond market is fretting about both high growth and high inflation, he said, with neither actually present in the economy.
Part of the recent rate rise was in reaction to the 4% annualized first- quarter rise in the consumer price index, he said. But the CPI is widely seen as overstating inflation - and it was not used to figure the inflation-adjusted growth rate in first-quarter gross domestic product.
In fact, if the CPI figure had been used, inflation-adjusted first- quarter GPD growth would have been a subpar 1%. Instead, he said, the 2.5% inflation reading from the "implicit deflator" index - regarded by economists as far more accurate than the CPI - was used.
Mr. Orr said he expects the federal funds rate, now set at 5.25% by the Federal Reserve, to be 50 basis points lower by next March 31, with the prime rate falling a similar amount, to 7.75%. He also expects the long bond yield to fall back to 6.15% and the 30-year mortgage rate to recede to 7.25% from nearly 8% right now.
"With hindsight, the big rise in bond yields in 1994 was probably the major reason the economy slowed in 1995, and the big drop in bond yields last year seems to be the important stimulus to growth in 1996 so far," said Edward Yardeni, chief economist at Deutsche Morgan Grenfell/C.J. Lawrence Inc.
"And the rapid backup in bond yields we've seen recently is going to have a depressing impact, slowing things down in the second half of the year," he said.
Wayne Ayers, chief economist at Bank of Boston Corp., noted signs that the growth numbers for the second quarter "will be very close to what we saw in the first quarter."
"The issue going forward is what to expect in the second half of the year," he said. "With Fed policy still relatively restrictive and (federal) budget policy restrictive, we should see a more subdued economy in the second half."
Mr. Ayers sees little likelihood the Fed will be compelled to raise rates, as some in the markets have feared. "It's extremely doubtful the Fed would tighten credit in the sixth year of an economic expansion," he said.
The key, of course, is inflation. Few economists see any pickup in costs, which ultimately augurs lower rates.
"Core inflation remains low, and inflation fundamentals favorable," said Mickey D. Levy, chief financial economist at Nationsbanc Capital Markets, a subsidiary of NationsBank Corp. He dismissed concerns about recent price increases in energy and agricultural products.
"These one-time price increases add to the general price level but do not raise core inflation unless accompanied by easier monetary policy from the Fed," he said. Without this, such price increases simply reduce spending in other areas and thus restrain the economy.
Concerning rates, most economists expect the Fed to remain on hold until July at the earliest. It may stand pat the entire summer - and perhaps the rest of the year, given the presidential election campaign that will dominate the autumn.
"Actually, we don't have much to complain about," said Mr. Yardeni. "We have decent economic growth and low inflation. I think that even the bond market will get around to concluding this isn't so bad."
