Past as Prologue on Rates
direction of interest rates in 1991 are easy to identify, the health of the economy and the Federal ReserveÛªs response to it A dearer picture of what happened to interest rates in 1991 is obtained by looking at short-term rates out to seven years and longer-term rates out to 30 years. Short rates fell under the sway of the wishes of the Fed, while the longer rates are affected by other forces.</br></br>Through the first half of the past year, there was the belief that once Operation Desert Storm in the Middle East had been terminated, consumers would begin to spend more and the economy would improve. The economy, as measured by the new gross domestic product, did finally improve in the third quarter, but it has been anemic ever since. At his recent congressional testimony, Fed Chairman Alan Greenspan admitted that he was deceived into believing that the economy was improving, and only recently did he realize that the opposite was occurring.</br></br>AH of this anticipation has been borne out in the movement of interest rates this year. Through the middle of the year, short rates moved somewhat lower, while the longer rates moved higher. As a result, the Treasury yield curve, as measured from the two-year note to the 30-year bond, steepened from 102 basis points to 146 basis points. It wasn't until the last half of the year, and especially in November and December when the Fed dropped the discount rate by 150 basis points, that the curve moved to a much more positive 276 basis points.</br></br>The distinction to be made here is that the Fed, in controlling both the discount rate and the federal funds rate, was able to control short rates out to seven years. In its recent dramatic reduction of the discount rate by a full percentage point to 3.5	percent, the Fed served notice of its concern about the economy and its fears of what the government might do in the way of ÛÏhelping the situation through tax cuts and increased spending.</br></br>William Griggs, co-author of the Griggs & Santow Report, a weekly Wall Street money market newsletter, believes that long interest rates have been influenced by the perception that tire economyÛªs problems are not just cyclical in nature, but : are long-run problems that would be present long after the recovery was underway and, in feet, that these problems - ÐÊ would have a negative influence on the recovery itself.