Short-Term Rates May Have Bottomed Out

In the wake of positive economic news late last week, many economists now believe the recession is ending and that short-term interest rates have bottomed out.

If they are right, then banks that haven't issued debt lately, particularly debt with maturities of less than three years, will be thinking more seriously of coming to market.

Improving Bank Margins?

Furthermore, rising short-term rates would allow banks to improve their margins. Even if rates on Treasuries rise only slightly, banks will be able to increase some of their lending rates while maintaining their borrowing rates.

"The latest economic news suggests the recession has hit bottom. There doesn't appear to be any incentive for the Fed to ease" in the short term, said Henry Engler, chief economist at Chemical Banking Corp.

In April, the index of leading economic indicators rose 0.6%, and factory orders posted a 1.8% increase, the Commerce Department reported last week. For the leading indicators, it was the third consecutive monthly increase.

Economists' Concern

Before last week, a number of economists had been concerned that the recession would be longer than expected and that the Federal Reserve Board might reduce interest rates again.

U.S. Treasury Secretary Nicholas Brady Tuesday echoed economists' thinking about the economy.

In Paris for the annual ministerial meeting of the Organization for Economic Cooperation and Development, he told reporters, "It seems to me that the United States has bottomed out."

The federal funds rate target for bank overnight borrowing has fallen from 8.25% to 5.75% in the past year. Yields on three-month Treasury bills have fallen in concert, from a 7.99% average last June to 5.73% Tuesday.

Nowhere to Go But Up?

With at least short-term rates looking as though they have nowhere to go but up, experts said banks may want to take advantage of the window.

"You might see anyone interested in issuing debt getting a move on," said John Ross, head of funding at Bank of New York Co.

Forty-nine banks have issued $5.315 billion worth of debt this year. Barnett Banks Inc.'s $100 million 10-year subordinated debt issue two weeks ago is among the most recent.

But among money-center banks, Chase Manhattan Corp. has issued no debt this year, according to Securities Data Corp.

While most believe the worst is over, economists are still cautious about saying the recession is over. Many are awaiting Friday's May unemployment figures as well as the May consumer price index, producer price index, and retail sales figures. Those are due out in mid-June.

Disagreement also remains on what medium and long rates will do.

Some, like Bradford H. Warner, treasurer of Bank of Boston Corp., said they believe long rates will fall a bit in coming weeks.

With the yield curve at its steepest in six years and economists predicting a sluggish recovery, Mr. Warner said, fears of inflation - which typically drive up long-term bond yields - won't be a big factor. Rather, he said, investors looking for better returns will move into longer-term Treasuries, pushing down their yields.

Others said they believe inflation fear will persist and keep long rates higher. [Graph Omitted]

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