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FEDERAL RESERVE BANK OF NEW YORK 23 Som e Econom ic P roblem s of 1967 * By A l f r e d H a y e s President, Federal Reserve Bank of New York As we emerge from the difficult year of 1966 and face the uncertainties of the new year, it is not too much to hope that the stresses and strains will be less severe, and the problems less perplexing, than in the year we have just lived through. I shall not burden you with anything more than a brief and therefore oversimplified reference to last year’s difficulties in the areas in which you as bank ers, and I as a central banker, are especially interested. The balanced business expansion of 1961-64 gave way in mid- or late 1965 to an overheated economy, mainly because a greatly expanded war effort in Vietnam was superimposed on a peacetime economy m arked by grow ing capital expenditures and nearly full utilization of labor resources and plant capacity. As a result, prices and costs came under increasing pressure, bringing to an end the fine price-cost record of the early 1960’s. In a situation in which a combination of fiscal restraint and monetary re straint was clearly needed, monetary policy had to carry the major share of the burden of counteracting the in evitable inflationary pressures that followed from these circumstances. As many of us in the Federal Reserve System have often pointed out, the penalty of having monetary policy carry this heavy burden is usually the de velopment of almost unbearable strains in financial m ar kets, with excessive increases in interest rates— and last year’s experience amply proved the point. Much has changed, of course, since last summer. Above all, the domestic economy has cooled off perceptibly; and, while credit demand has remained high, it has been less insistent than in earlier months, market rates have de clined sharply, and market expectations have undergone a * An address before the thirty-ninth annual midwinter meeting of the New York State Bankers Association, New York City, Jan uary 23, 1967. fundamental change. Last m onth’s termination of the Federal Reserve statement of September 1, 1966 on busi ness loans and on discount administration was widely regarded as evidence of a significantly less restrictive Sys tem attitude. The President’s proposal for a 6 per cent surcharge on taxes appears to me to be a constructive move toward providing a better mix of fiscal and mone tary policies to meet the new conditions we will face this year. The relation of these policies to the unfolding eco nomic and financial scene will undoubtedly be a m atter of continuing importance and interest to all of us in 1967. While 1967 is bound to be different from 1966, I think it would be unwise to assume that we can relax and ex pect that the nicely balanced and vigorous expansion of the early 1960’s will be automatically restored. In fact, as we enter 1 9 6 7 ,1 am impressed by the seriousness of some of our unsolved economic problems. Perhaps this is a good time to take stock of our position and, without attempting a forecast, to suggest where some of these problems are most likely to develop as we seek to achieve our basic economic goals. Those goals, as you know, are maximum sustainable economic growth, high employment of re sources, substantial price stability, and near-equilibrium in our international payments. Doubts as to whether we shall see an adequate rate of economic growth seem to be a m ajor source of public con cern at present. There is a good deal of talk among econ omists, both in and outside the Government, about the possibility that we are on the verge of a recession. They cite such items as the probably much slower gain in busi ness outlays on plant and equipment in 1967 than in 1966, with a dim profit outlook as a strong causal factor; the probability of an inventory correction following the recent tendency for inventories to accumulate at an ex cessive pace; and the prospect of somewhat lower auto mobile sales, on top of already sharply depressed housing construction. 24 MONTHLY REVIEW, FEBRUARY 1967 It would, of course, be foolish to dismiss out of hand the possibility of recession. Nevertheless, I find the case for recession decidedly unconvincing. O ur Bank endeavors to keep in close touch with a representative cross section of businessmen, and most of them look for considerable sales gains in 1967, though profit prospects are much less certain. And even the most pessimistic forecasts seem to envision a sizable growth in GNP in the current year. Above all, it is hard for me to conceive of a recession de veloping in the face of the advance in Federal defense expenditures that seems probable in the light of Vietnam. Admittedly, this is an area full of uncertainties— but the probabilities seem to favor continued significant expan sion of Federal spending. Also, outlays of state and local governments are likely to increase by an amount no less expansive than last year’s record gain. Perhaps the argument about the danger of “recession” is more a m atter of semantics than of substance. I have a feeling that many of those who use the term are thinking more of a drop in the rate of growth of the economy than of an actual contraction. Of course the economy’s rate of growth has slowed. It was quite natural to expect such a slowdown as the slack of unused resources in our econ omy was absorbed; and, indeed, it was necessary to en courage the slowdown through official policy in order to prevent a disorderly scramble for scarce resources and even greater price increases than actually occurred. In periods of high employment, such as 1966, real growth potential is closely dependent upon net additions to the labor force as determined by population trends. Moreover, in such periods productivity gains also tend to slow down— as clearly occurred in the past year— further reducing the economy’s potential for real growth. In this setting, it seems reasonable that our goal with respect to growth should be more modest in the next year or two than in the early 1960’s. Perhaps a real growth rate of around 4 per cent would be a reasonable objective under current circumstances, although it might be necessary to accept temporarily a slightly slower growth rate as a means of achieving a satisfactory degree of price stability. In any case, I see no reason why a growth rate of this general magnitude should be a prelude to genuine recession. On the contrary, at this stage an orderly stepping-down to a sustainable growth rate is much less likely to lead to re cession than would a resumption of excessively rapid and unbalanced growth. It would, of course, be desirable not just to avoid a re cession but to bring about a further decline in unemploy ment. But, it is pretty generally recognized that further substantial reduction of unemployment is a longer run m atter, and must depend primarily on the gradual effects of structural improvements which may result from pro grams to improve training, labor mobility, and general standards of education and health. There are still severe shortages of many types of skilled labor, so that any effort to reduce unemployment further merely by stimulating aggregate demand would probably do much more harm than good. One of the disturbing aspects of the present economic debate is the apparent willingness of too m any people to accept considerable cost and price increases as inevitable in the coming year. To some extent, of course, excessive demand always has lagged effects on prices and costs, and we are seeing such effects now even after the cooling of the economy which I have mentioned. F or one thing, the wage structure is under mounting pressure as a con sequence of earlier increases in the cost of living. If the large number of m ajor wage negotiations scheduled for 1967 tend to follow or exceed the recent 5 per cent pat tern, they will be far in excess of any likely national pro ductivity gains and will therefore add to inflationary pressures. The tendency toward cost-of-living escalator clauses is likewise disturbing. It is one thing to say “some degree of inflation is in evitable but let us try to limit its extent”, and it is quite another thing to say “inflation will happen anyway and we can do nothing about it” . Both private and public policies can be of great value in restraining the degree of upward cost and price pressures, and appropriate policies— not only in the monetary and fiscal area, but also in the wage and price decisions of labor and management— are likely to be sorely needed this year. To put it in another way, in my judgment, the risk of inflation over, say, the next twelve months, still outweighs the risk of recession by a substantial margin. And, as I have pointed out on other occasions, ground lost to inflation is usually lost per manently. So far I have said very little about developments in the area of credit and financial markets. There appears to have been a net decline in bank credit in the three-m onth period of September through November, at least if our seasonal adjustment factors did not go badly astray. This was cer tainly more than we had looked forward to. To some ex tent, this sharp reversal was perhaps a natural counterpart of excessive fears and consequent overborrowing in the earlier months of the year and of the speedup of corporate tax payments in the second quarter. But it also reflected a greater reluctance of banks to lend in the light of the significant reduction in bank liquidity. In any event, it is gratifying to note that the figures for December and early January point to a resumption of bank credit expansion. So far, most of the curtailment in credit expansion dur FEDERAL RESERVE BANK OF NEW YORK ing the fall months seems to have been due more to neces sitous rationing by the lenders than to any weakness in credit demand. I have the impression that bankers con tinue to look for rather strong loan demand in the coming months. In many instances, however, their liquidity posi tion will probably induce continued caution in the rate of expansion of their lending operations. O n the other hand, the decline in market rates over the past couple of months has placed the banks in a greatly improved position with respect to retention or expansion of time deposits. Other savings institutions have also experienced a vast improve ment in their flow of funds. Demands in the capital m ar ket from both corporate and municipal borrowers remain heavy, and while passage of the President’s new tax pro posals will limit the demands of the Federal Government, these will still be substantial. While I shall not be so rash as to attempt any forecast of interest rates, I think it is well to bear in mind that rates are the result of many varied forces operating on both the demand and the supply side of the market. No review of the problems we face can neglect our balance of payments and our international position gen erally— an area which is a m atter of deep concern. In any review of the past year’s experience, it is obvious that Vietnam has been an im portant adverse factor. Without trying to set a figure on this influence, I would point out that in addition to the direct military outlays abroad there are a variety of indirect effects, including of course those reflecting the overheated condition of our domestic econ omy in 1966. After so many years of continuous deficit and so many high-level assurances to the world that our payments would be brought into balance, I think it es sential that this goal receive urgent attention from all elements in this country, private and public, which are capable of contributing to a remedy. Unfortunately, achievement of balance in our external accounts will be anything but easy. O ur biggest hope lies in the expansion of the trade surplus. Perhaps we can reason ably look for an improvement on the im port side, provided that the expansion of the domestic economy does not be come excessive, but we should not overlook the fact that some of the foreign countries that are our major export customers are also tending to grow at a more moderate pace, and this may have implications for our export pros pects. In general, I think it is fair to say that our world competitive position has been well sustained, but must be made even stronger. The cost and price pressures cur rently in prospect must, therefore, be strongly combated if we are to avoid undermining our international trade position. Turning to international capital flows, we find a variety 25 of crosscurrents, but on balance we benefited greatly in 1966 from tight credit conditions in this country and the resulting high interest rates. We can hardly hope for ben efits of similar magnitude in 1967. Indeed, whereas the inflow of private foreign short-term funds brought a small surplus in our official settlements account last year, we shall be lucky this year if some reflux of these funds does not develop. In general, even the slackening of credit pressures and the decline in interest rates which we have seen already in the United States may have appreciable adverse effects on net capital flows, unless there is an equivalent reduction of credit pressures and interest rates in m ajor foreign countries. To some extent such a parallel reduction of credit pressures has occurred so far, but it cannot necessarily be counted on. Under these circum stances, I think it was inevitable and highly desirable that the voluntary credit restraint program should be continued and indeed modestly strengthened for the year 1967. R e gardless of this program, however, excessively easy domes tic credit conditions could have a disturbing effect on our balance of payments. I am quite aware that artificial restraints on international capital flows are in principle undesirable. But, as I view the alternatives, artificial restraints are a lesser evil, re quired for the time being to prevent a greater evil in the form of weakening of confidence in the dollar. Certainly measures of this kind are not suitable permanent com ponents of a desirable system of international financial payments. Thus, it behooves us, and all the other major industrial nations, to continue our efforts to achieve means of adjustment that are of an expansive rather than of a contractive nature. F or the United States this means, above all, continued emphasis on the achievement of a larger cur rent account surplus. Naturally, it is hard for our industrialists to accept any restriction on their freedom to invest wherever in the world they see interesting profit possibilities. We often hear ex pressed the view that any interference with direct Am er ican investment abroad (i.e., investment in plant and equipment or working capital of subsidiaries or branches) must be wrong, in view of the splendid returns earned consistently on the aggregate of such investments in recent years. It is also true that the United States, because of the sheer size of its economy and of its national savings, and the high efficiency of its financial institutions, should be a natural supplier of capital to the rest of the world, especially the less developed countries. As for the attitude of the recipient countries toward in flows of American capital, it is impossible to generalize. In some countries the desire to obtain the most up-to-date American machinery and technical methods runs head 26 MONTHLY REVIEW, FEBRUARY 1967 on into the familiar argument that too much of the coun proposal for a temporary but general tax increase. While, try’s industry is falling under American domination. R e currently, the need to restrain an overheated economy is luctance of some countries to accept American investment somewhat less pressing than earlier, the size of the pro has been tempered by the realization that, if obstacles are jected Federal deficit is such that an increase in revenues created, the American concern in question will probably seems much in order. We could easily discover in the carry out the same plans in a neighboring country. Thus, months ahead that the economic expansion was again ac the first country may ultimately feel all the competitive celerating. In view of the rather lengthy period that is effects of the new plant’s establishment without receiving usually needed to translate a proposal to raise taxes into any benefits that accrue from having the plant located on actual legislation, I think it highly prudent to have a pro its own soil. I should not overlook the feeling of many posal already on the table and under active consideration. large American corporations that expansion abroad is an Admittedly, however, this is an area in which others have absolute must if the corporation is to retain an adequate responsibility and special competence. The only reason degree of dynamism and can also be of great benefit in I speak of it at all is because of the close relationship with helping to sustain exports from American plants. Just to our own activities and my fervent belief that monetary and complete this picture of confusion, I might mention also fiscal policy must work together for the solutions of the the attitude of some of the foreign Finance Ministers and nation’s economic and financial problems. I am rather central bankers who may regard such American invest confident that, on the strength of the lessons learned in the ment, at the time it is made, as an unwanted source of past year, the nation will succeed in achieving a m uch additional foreign exchange and an unwanted contributor more orderly progress in the coming year. But this will to inflationary pressures in the economy of their country. require the keenest vigilance on the part of all of us, and Having sketched the problem, I suppose I should have I am sure we would all agree that the goal is worthy of the some solution to offer. Unfortunately, however, I do not effort. think there are any easy solutions. Perhaps the relationship And I know that, as I have sketched the problems our between a free flow of American investment abroad and economy may face in the coming year, you have been the reserve policies of foreign monetary authorities de thinking of how those problems— and our efforts to deal serves further study. More broadly, it seems to me that with them— will affect you and your institutions. Many possibly the most challenging problem which this country of you faced great difficulties last year as insistent credit faces in the sphere of international economics is how to demands found you with inadequate funds to satisfy all reconcile equilibrium in our balance of payments with the your creditworthy and long-established customers. M ore fulfillment of our vitally im portant role as a supplier of over, you watched with some apprehension as your loancapital, both private and Government, to other parts of deposit ratios rose and your liquidity dwindled. I would like to suggest that, if efforts to keep the economy fully the world. Perhaps I have said enough to indicate that 1967 is not employed and growing at something near its full potential likely to be an easy year for policy makers or for anybody are successful, you will continue to face similar problems. else. Quite to the contrary. The task to be faced by mone You will have to continue to make sound judgments when tary policy will hinge not only on the pace of the economy, allocating the resources available to you. If you make on cost-price pressures, and on international payments de those decisions in ways which promote the best long-term velopments, but also on the role of the Federal budget in interests of your community and the nation, the problems adding to our burdens or helping to alleviate them. It seems ahead will be less difficult than they would be otherwise. to me that on balance a less stimulative Federal budget has In short, there is a job for all of us to tackle, and I solicit been needed for some time, and I welcome the President’s your cooperation. FEDERAL RESERVE BANK OF NEW YORK 27 T he Business Situation Demand pressures at the close of 1966 were distinctly more moderate than was the case earlier in the year. A year ago, personal consumption expenditures, business capital outlays, and defense requirements were all rising rapidly, threatening to reach levels well in excess of the practical limits of available labor and capital resources. In such circumstances, it was to be expected that infla tionary pressures would be set in motion, as clearly hap pened in the first half of 1966. By the year-end, however, efforts to combat inflationary excesses had succeeded in dampening the rate of growth of overall private demand, thus helping to make available the resources necessary for increased defense production while at the same time pro viding some measure of relief in the overall call made on the nation’s production capacity. Although recent estimates of gross national product (G N P) in the fourth quarter of 1966 indicate a rate of gain higher than that of the third quarter, this development primarily reflected a sharp increase in the rate of inventory accumulation. Final expenditures— GNP less inventory in vestment— actually grew more slowly in the fourth quarter than in the third. Defense expenditures expanded a little less rapidly but still accounted for about one fourth of the advance in total GNP. Increases in capital spending by business, although still considerable, took a smaller share of the total expansion of output than in earlier quarters of the year. Consumer spending advanced relatively little, despite a substantial increase of disposable personal in come, and residential construction outlays dropped further. In the meantime, however, there are indications that the residential construction decline may soon bottom out. Total industrial production rose from the third to the fourth quarter of the year at a comparatively modest annual rate of 2% per cent. A t the same time, the rate of utiliza tion of manufacturing capacity, while remaining at a high level, edged off slightly in the fourth quarter. The average workweek in manufacturing also shortened somewhat in December. Despite some reduction in overall demand and supply pressures, production costs continue to increase and pres ently show little prospect of easing. Unit labor costs in manufacturing are estimated to have risen at a 6 per cent annual rate from July to December. Moreover, the GNP deflator— the broadest measure of price changes in the economy— rose at an annual rate of more than 3 per cent during the fourth quarter, somewhat less rapidly than the 33A per cent rate registered earlier in the year but almost twice as fast as in 1965. GROSS N A T IO N A L PRODUCT IN T H E F O U R T H Q U A R T E R O F 196 6 The nation’s total output of goods and services increased by $13.8 billion in the final quarter of 1966, to a seasonally adjusted annual rate of $759.1 billion, according to pre liminary estimates by the Departm ent of Commerce. This sizable advance— at an annual rate of IV 2 per cent— was somewhat larger than that of the preceding three-month period, although it fell well short of the outsized increase recorded during the first quarter of 1966. Of the $13.8 billion added to GNP during the fourth quarter, however, only some $8 billion constituted a real increase in goods and services produced; the remaining $5% billion re flected merely higher prices. Nevertheless, even when ad justments are made for price rises, the growth in GNP was at a strong annual rate of nearly AVi per cent, compared with 4 per cent in the third quarter, 2 per cent in the sec ond, and 6 per cent during the exceptional first quarter of 1966. About one third of the increase in GNP during the fourth quarter was due to inventory accumulation (see Chart I ) . Inventories are estimated to have risen at an un usually high annual rate— $14.4 billion— with sharp rises recorded in work-in-process inventories held by durables manufacturers, notably in the machinery and transporta tion equipment industries. But manufacturers’ inventories of finished goods also increased rapidly, as did wholesale and retail trade inventories. In contrast, final expenditures 28 MONTHLY REVIEW, FEBRUARY 1967 Chart I RECENT CHANGES IN GROSS NATIONAL PRODUCT AND ITS COMPONENTS Seasonally adjusted annual rates ] Quarterly change, second quarter ) to third quarter 1966 ■ Quarterly change, third quarter to fourth quarter 1966 GROSS NATIONAL PRODUCT Inventory investment Final expenditures Consumer expenditures for durable goods Consumer expenditures for nondurable goods Consumer expenditures for Residential construction Business fixed investment Federal Government purchases State and local government purchases Net exports of goods and services 1____ -5 0 5 10 15 Billions of dollars . * Source: United States Department of Commerce. — total GNP less inventory investment— rose by a rela tively modest $9.3 billion, which was considerably below the $15.4 billion increase recorded in the preceding quarter. The consumer sector showed a distinct lack of buoy ancy during the fourth quarter, and the $4.5 billion in crease in total outlays for consumption was only half the gain of the preceding quarter. In real terms, the fourth quarter’s advance in total consumption expenditures was negligible— $0.2 billion, as against a $6.9 billion gain in the third quarter. Consumer spending for durable goods de clined fractionally during the fourth quarter, and was actu ally slightly less than in the opening months of 1966. Out lays for automobiles and parts, although virtually unchanged from the third-quarter level, were significantly lower than at the start of the year. Expenditures on nondurable goods did increase, but the advance was the smallest in three years and was more than accounted for by higher prices. Consumers increased their expenditures for services by as large a dollar amount as in the third quarter, but almost two thirds of the increase went simply to pay for higher costs. The slowing of consumer spending seems not to have reflected a general lack of funds. Indeed, disposable per sonal income in the fourth quarter expanded at a very rapid $10.4 billion seasonally adjusted annual rate, com pared with a $7.9 billion gain in the preceding quarter. At the same time, while outstanding consumer credit ad vanced less rapidly in the fourth quarter than in the third, the availability of such credit appears to have been m ain tained, if not increased a bit. The recent small increases in consumer outlays on goods and services have appar ently resulted from a num ber of causes, including a grow ing uneasiness among the general public, prom pted by un certainty regarding the economic outlook, price develop ments, the war in Vietnam, and the possibility of a tax increase. It should also be stressed, however, that the slower rise of consumption than of disposable personal income in the fourth quarter may simply have reflected the desire of consumers to increase the proportion of their income saved. During most of the current expansion, consumers have been saving an unusually small share of their disposable incomes. This development, which in the last year or two probably reflected in good part efforts to maintain an advancing standard of living in the face of rapidly rising prices, had brought the savings rate down to an exceptionally low level by the third quarter of 1966. In the fourth quarter, however, the savings rate returned to a figure more in line with the long-term average. Residential construction expenditures again fell sharply in the fourth quarter— by $3 billion— to a level one-fourth below that of the first quarter of 1966. A t the same time, however, housing starts and other indicators of prospec tive home-building activity improved somewhat during the period, leading many observers to conclude that the decline in home building might be nearing an end. Business fixed investment outlays increased less in the fourth quarter than in the third, but the $1.4 billion ad vance nevertheless remains large by historical standards. The survey of plant and equipment expenditures taken last November by the Departm ent of Commerce and the Securities and Exchange Commission had already revealed that capital spending was increasing at a lesser pace dur ing the fourth quarter, and indicated that further slow downs in such spending were likely in the current and following quarters. There are a num ber of factors behind this leveling off. Perhaps the main one is that the pace of economic activity has begun to moderate, while the pres sure on capital resources is easing slightly as new capacity created by past spending comes into use. The Federal R e serve Board’s index of capacity utilization edged off by 1 percentage point during the fourth quarter, to the still very FEDERAL RESERVE BANK OF NEW YORK high level of 90 per cent. At the same time, profit margins have come under progressively stronger pressure as labor costs per unit of output m ount rapidly. National defense expenditures rose steeply in the fourth quarter, by $3.5 billion, following an even sharper up surge of $4.9 billion in the preceding quarter. By the end of the year, defense spending was $13 billion higher than in the fourth quarter of 1965, while for the full year 1966 the advance over the preceding year amounted to $10 billion. Federal Government purchases of nondefense goods and services, on the other hand, did not rise during the fourth quarter. The budget recently submitted to Congress calls for fur ther substantial increases in Federal Government pur chases of goods and services. In his Economic Report, the President stated that defense expenditures would rise by another $10 billion during calendar year 1967, while all other Federal purchases would increase by %IV2 billion. Because of the stimulus of Government spending and a basically strong private demand situation, the Council of Economic Advisers expects that the economy will con tinue to move ahead in 1967 and will gather strength after midyear. This projection assumes, it might be noted, that Congress will act favorably on the President’s budget plans, including the proposed imposition of a 6 per cent surcharge on both corporate and personal income taxes. The surcharge would be introduced on July 1 and, accord ing to the President, would “last for two years or for so long as the unusual expenditures associated with our efforts in Vietnam continue”. RECENT D E VELO PM EN TS According to the preliminary estimate, industrial output remained virtually unchanged in December. The Federal Reserve Board’s index edged up by 0.1 percentage point, to 158.7 of the 1957-59 average, after having eased by 0.2 percentage point in November. As in the past few months, there was a substantial decline in iron and steel production but large increases in the output of business and defense equipment. Automobile production, on the other hand, remained at a seasonally adjusted annual rate of 8 V2 million units in December but declined to a 7 Va million unit level in January. Mining output rose substan tially, reflecting primarily a sharp recovery in coal pro duction, while utilities production also increased. M anufacturers’ shipments, which had declined slightly in November, rose more than 2 per cent, or by $1.0 billion, in December. Considerable strength was apparent in both the durables and nondurables components. Equipment and defense producers, as well as manufacturers of consumer 29 nondurables, had particularly large increases in sales. Along with the strong performance of shipments, the in crease in m anufacturers’ inventories m oderated substan tially in December, amounting to $0.8 billion after seasonal adjustment, as against a $1.1 billion advance in November. The rise in durables m anufacturers’ inventories, in partic ular, slowed to $0.6 billion from $1.0 billion in the preced ing month. The overall inventory-sales ratio in manufac turing declined slightly in December for the first time in seven months, but remained high in comparison with earlier levels. The volume of new orders received by durables manu facturers rose $0.9 billion to $23.9 billion in December, following two consecutive months of decline that totaled $2.2 billion. M ore than half of the December increase re flected the movement of defense orders, as had been the 30 MONTHLY REVIEW, FEBRUARY 1967 case for the bulk of the earlier decline. Unfilled orders of durables manufacturers remained virtually unchanged in December. Personal income, which had risen exceptionally rapidly from July to November, grew more slowly in December. Nevertheless, that m onth’s $3.0 billion advance was close to the high average advance recorded in the first half of 1966. Wage and salary disbursements were up by a sub stantial $2.3 billion, while transfer payments rose by fully $1.0 billion. Dividend receipts, on the other hand, fell sharply— by $1.4 billion— presumably reflecting declines in the profits of some corporations and the need to con serve cash. Consumer credit outstanding increased in De cember by the smallest monthly amount in almost five years, primarily as a result of a very modest advance in outstanding automobile credit. Many of the series bearing on the outlook for residential construction have improved somewhat in recent months. Seasonally adjusted residential building contracts, which by October had fallen 43 per cent from their M arch high, rose by 13 per cent in the following two months. Over the same period, building permits for new private housing units dropped by 44 per cent through October, but then rose 8 per cent by December. Private housing starts between Oc tober and December recouped more than one third of their 46 per cent decline from M arch to October. The upturn in starts, moreover, was broadly based geographically (see Chart II ) . In assessing these developments, however, it should be recognized that the starts series is highly erratic and that more than two months of data are necessary to establish a trend in any of the statistics mentioned. The housing contraction in 1966 undoubtedly resulted pri marily from a shortage of mortgage funds at those institu tions specializing in this market. Recently, however, a sig nificantly larger volume of funds has flowed into mortgage lending institutions. In addition, the Federal Home Loan Bank System has made available $1.5 billion of credit to member savings and loan associations for mortgage lend ing. To encourage member associations to avail themselves of the released funds, the interest rate charged on the bulk of these advances has been reduced to 5% per cent. With the basic demand for housing apparently remaining strong, the easing in the mortgage market is likely to lead to a marked improvement in home building. Still, some time will be needed before the rise in housing starts is reflected in actual outlays. Even though the present indi cations do not suggest an immediate return to the high levels of residential construction prevailing before the 1966 slump, even a modest improvement of housing outlays would remove a m ajor drag on the overall growth of GNP. FEDERAL RESERVE BANK OF NEW YORK 31 Recent Banking and M onetary D evelopm ents Commercial banks, which had experienced strong liquid ity pressures in the summer months of 1966, found condi tions significantly easier in the final quarter of the year. The Federal Reserve System acted during the period to relieve pressures in the money markets so that bank credit growth might resume. As short-term interest rates fell, the ability of commercial banks to attract and retain time de posit funds gradually improved, and by December the ex pansion of total bank credit and deposits began to pick up markedly. The net reserve position of member banks in the aggregate eased during the quarter, as borrowings at the Federal Reserve Banks declined appreciably and excess reserves remained roughly unchanged. During the first three quarters of 1966, pressures on banks had progressively increased, reflecting both inten sifying loan demand and diminishing reserve availability. Banks responded to this development in several ways: they liquidated large amounts of securities, raised the prime rate to their business borrowers, increased other lending rates, tightened compensating balance requirements, and sought to scale down loan requests. A t the same time, many banks attempted to raise funds by competing more aggres sively for both large- and small-denomination certificates of deposit (C /D ’s), some borrowed heavily in the E uro dollar market, and some increased their borrowings at the Federal Reserve Banks. In the fourth quarter, however, the combination of firmer control over lending at commercial banks and a slowing in some sectors of the economy op erated to reduce substantially the growth of business loans, thereby alleviating one of the key sources of pressure on bank portfolio and reserve positions. Indeed, business loans grew less rapidly in the fourth quarter of 1966 than in any quarter since early 1961. Less pressure on reserve positions and the moderation in business loans made it possible for banks in November and December to increase their holdings of United States Government securities sufficiently to offset heavy October liquidations. Also, holdings of other securities held steady in the fourth quarter, following a small net reduction on a seasonally adjusted basis in the preceding three months. The expansion of total loans remained at the reduced pace of the third quarter of the year. The money supply declined slightly further in the fourth quarter, and total time and savings deposits at com mercial banks rose by only a small fraction of their gain earlier in the year. There was a widespread improvement in time deposit growth in December, but for the quarter as a whole smaller denomination “consumer-type” time de posits issued by banks advanced noticeably more slowly than in the preceding nine months, and large C /D ’s and passbook savings again declined. B A N K C REDIT A N D LIQ UIDITY Despite a strong December gain, total loans and invest ments of commercial banks1 expanded during the final three months of the year at a modest 2.6 per cent season ally adjusted annual rate (see C hart I ) . The decline in seasonally adjusted total bank credit that showed up in the statistics for September continued into the early part of the fourth quarter. However, the changed pattern of corporate tax payments and tax borrowing— a develop ment not accounted for in the seasonal adjustment fac tors— may have contributed to this abrupt decline. For the year as a whole, total bank credit grew 5.9 per cent — much more in line with real economic activity than the 10.2 per cent gain of 1965 (see Chart II ). Total loans less securities loans at all commercial banks grew at a 3.0 per cent seasonally adjusted annual rate during the fourth quarter, bringing the rate for the entire year to 10.0 per cent, one-third below the 1965 pace. Loans to brokers and dealers for purchasing and carrying securities, however, expanded strongly in the fourth quarter— especially in December— as nonbank United 1 The data for bank credit and relevant components have been adjusted to eliminate the effects of the exclusion of loans related to hypothecated deposits and the reclassification of participation cer tificates, both beginning June 15, 1966. 32 MONTHLY REVIEW, FEBRUARY 1967 Chart I QUARTERLY RATES OF CHANGE IN CREDIT AND LIQUIDITY INDICATORS DURING 1966* Seasonally adjusted annual rates I II III IV I II III IV I I! Ill IV ! II III IV Commercial banks in December expanded their holdings of United States Government securities by $1.4 billion (seasonally adjusted), in an apparent attem pt to rebuild their liquidity positions. F or the quarter as a whole, how ever, holdings of Governments at all commercial banks were unchanged on a seasonally adjusted basis, with the November and December increases offsetting the heavy October liquidation. Holdings of other securities by com mercial banks remained steady during the fourth quarter, on a seasonally adjusted basis. For the year as a whole, other securities— which mainly consist of tax-exempt obligations of state and local governments and issues of United States Government agencies— were higher by $2.5 billion, the smallest increase since 1960. Holdings of Government se curities declined by the same amount in 1966 as in 1965— $3.4 billion. The loan-deposit ratio of commercial banks in the aggre gate remained virtually unchanged at 65.5 per cent during the fourth quarter. A t New York City weekly reporting banks, however, where negotiable C /D ’s declined over the quarter, the loan-deposit ratio moved up 2.0 percentage points to an average of 79.6 per cent in December. Outside ^ End of quarter to end of quarter. "t Data include adjustments to eliminate the exclusion of hypothecated deposits end related loans beginning June 15, 1966. Source: Board of Governors of the Federal Reserve System. Chart I! YEAR-TO-YEAR PERCENTAGE CHANGES IN CREDIT AND LIQUIDITY INDICATORS* Percent States Government securities dealers took advantage of lower financing costs to rebuild their depleted inventories in anticipation of higher m arket prices in the new year. The fourth-quarter weakness in bank lending was espe cially apparent in the performance of business loans. The 4.6 per cent annual rate of increase of these loans was less than one half of the third-quarter pace, and was far below the exceptional 20.2 per cent first-half rate. The further slowing of business loans in the fourth quarter extended the downward trend that first began to show up after midyear, following especially heavy business tax borrow ing in the second quarter. The continued high cost and limited availability of bank loans may have resulted in greater reliance by businesses on alternative sources of funds during the fourth quarter. Overborrowing earlier in the year, reflecting fears of a future shortage of loanable funds, also could have been a factor in the slowdown of business loan expansion later in the year. Reduced busi ness loan growth in the second half of the year brought the expansion for the entire year to 14.3 per cent, down from the exceptionally strong 18.5 per cent expansion of 1965. Percent 12 10 8 6 4 2 0 —2 196164 Avg. 65 66 1961- 65 64 Avg. 66 196164 65 66 Avg. 196164 65 66 Avg. *En d of year to end of year. t Data include adjustments to eliminate the exclusion of hypothecated deposits and related loans beginning June 15,1966. Source: Board of Governors of the Federal Reserve System. 33 FEDERAL RESERVE BANK OF NEW YORK New York City, the ratio at weekly reporting banks de clined fractionally to 69.1 per cent. Member bank reserve positions were under decreasing pressure in the closing months of 1966. During the fourth quarter, nonborrowed reserves fell slightly on a seasonally adjusted basis, but required reserves were reduced some what more. As reserve availability improved during the quarter, banks were able to reduce their borrowings at Federal Reserve Banks, from a daily average of $766 mil lion in September to $557 million in December. Net bor rowed reserves dropped sharply from a daily average of $431 million in October to $161 million in December. Chart III TIME DEPOSITS WEEKLY REPORTING LARGE COMMERCIAL BANKS Billions of dollars Billions of doilars M O N E Y S U P P L Y , B A N K D E PO SITS, A N D L I Q U ID A S S E T S The slowdown in bank credit growth in the second half of 1966 was accompanied by a slowing of the growth of the total of money supply plus commercial bank time de posits (see Chart I ) . This series grew at a seasonally ad justed annual rate of only 1.0 per cent in the fourth quar ter,2 well below the already modest pace of the third quarter. For the entire year, the money supply plus time deposits expanded by 4.9 per cent, approximately one half that of 1965. The money supply— privately held de mand deposits plus currency outside banks— declined at an annual rate of 0.2 per cent in the fourth quarter, fol lowing a 1.4 per cent per annum rate of decline in the third quarter. In both quarters, the decline reflected a drop in privately held demand deposits; currency in cir culation outside banks continued to rise. The growth of the money supply for the entire year, at 1.9 per cent, was less than half the 1965 rate, and well below that of the 1961-64 period (see C hart I I ) . The attraction of high yields on competing forms of financial investment, reinforced to some extent by the reduced maximum permissible rate of 5 per cent on consumer-type time deposits put into effect on Septem ber 26, made it difficult for commercial banks to obtain and keep time deposits during the first two months of the quarter. Thus, despite some net gains in December, total time and savings deposits, on a seasonally adjusted daily average basis, rose only 2.3 per cent in the quarter, well below the 9.6 per cent pace of the previous quarter. For the year as a whole, these deposits expanded 8.3 per cent Note: Large C/D’s are defined as negotiable certificates of deposit in denominations of $100,000 or more. * Change in series due to a revised coverage of banks. "f- Data include adjustments to eliminate the exclusion of hypothecated deposits beginning June 15, 1966. *Other time deposits" equals total time deposits, less savings accounts and large C/D’s. Source: Board of Governors of the Federal Reserve System. as compared with a 16.0 per cent rate in 1965. One of the m ajor reasons for the modest growth in time deposits during the fourth quarter was the continued runoff in large-denomination C /D ’s outstanding. These deposits fell by $1.3 billion at weekly reporting banks over the three months as a whole, about the same as in the third quarter (see C hart II I). Faced with an interest rate ceiling of 5 Vz per cent on large C /D ’s, commercial banks in October and November continued to find it difficult to compete with higher yielding m arket instruments. How ever, in December, as rates on some competing money m ar ket investments declined, weekly reporting banks experi enced a $180 million increase in large C /D ’s, the first such increase since May. By the end of January, the further ex pansion of these deposits had brought the level of outstand ing C /D ’s back three fourths of the way to the peak of last August. 2 The time deposit data have been adjusted to eliminate the ef Another important reason for the diminished growth in fects of the exclusion of hypothecated deposits beginning June 15, total time deposits was the small fourth-quarter rise in 1966. 34 MONTHLY REVIEW, FEBRUARY 1967 “other time deposits”, which consists primarily of smalldenomination savings certificates. After growing rapidly during the first three quarters of 1966, these deposits ad vanced at weekly reporting banks by only $148 million in the final three months. This development was associated with attractive deposit rates at other savings institutions, coupled with the September reduction to 5 per cent (from 5 V2 per cent) in the ceiling rate on commercial bank time deposits under $100,000.3 According to preliminary estimates, holdings of liquid assets by the nonbank public, seasonally adjusted, moved up in the fourth quarter, but at a relatively low 3.6 per cent annual rate, just slightly above the already reduced rates of 3 See this R eview (October 1966), page 221, footnote 2. the second and third quarters (see C hart I ) . Growth for the entire year, at 4.9 per cent, was far below the 8.0 per cent rate of last year. The major factor limiting the rise of liquid assets in the final three months of 1966 was a sharp decline in holdings of United States Government securities with maturities of one year or less. Apparently, declining yields on short-term Government issues since mid-September made these somewhat less attractive to nonbank investors. Deposit growth at savings and loan associations and mutual savings banks improved in the final quarter of the year, how ever, and the November and December deposit gains were quite strong. Because gross national product advanced in the fourth quarter almost twice as fast as liquid assets, the ratio of the nonbank public’s holdings of liquid assets to GNP dropped to 78.9 per cent, the eighth consecutive quarterly decline in this broad-gauge measure of liquidity. N e w P u b lic a t io n s The Federal Reserve Bank of New York has published a 234-page book, Central Bank Co operation: 1924-31, by Stephen V. O. Clarke. In the foreword, Mr. Hayes, President of the Bank, states that the book deals with “the efforts of American, British, French, and German central bank ers to reestablish and maintain financial stability in 1924-31 and the frustration of those efforts during the financial crisis at the end of that period”. The author has used the historical records of this Bank and unpublished papers of various prom inent Americans to bring new insight to an im portant period of central bank history. Copies are available at $2.00 each. Educational institutions may obtain quantities for classroom use at $1.00 per copy. Money, Banking, and Credit in Eastern Europe, written by George Garvy, Economic A d viser, was published late last year by the Federal Reserve Bank of New York. The 167-page book examines the role of banking and credit policy in seven communist countries and focuses on developments arising from recent changes in economic policy. Copies are available at $1.25 a copy and at a special rate of 65 cents a copy to educational institutions on quantity orders. These books may be ordered from the Public Information Department, Federal Reserve Bank of New York, New York, N. Y. 10045, at the prices indicated, plus New York City sales tax, where applicable. FEDERAL RESERVE BANK OF NEW YORK 35 T he M oney and Bond M ark ets in January Prices rose considerably further in the bond markets in January, and most short-term interest rates declined ap preciably. The State of the Union message on January 10, in which the President requested a tax increase and ex pressed the Adm inistration’s intention to strive toward the attainment of lower interest rates, bolstered confidence throughout the financial markets and was followed by a sharp rise in the prices of stocks and bonds. Some caution appeared in the bond m arket around the time of the bud get message on January 24, when the m arket also awaited the terms of the Treasury’s February refinancing which some thought might be broadened to include a pre-refunding of issues maturing later this year. When the Treasury an nounced on January 25 a routine cash refunding of the February maturities through the sale of two new notes, bond prices rose. The advance accelerated after the cut in the British bank rate and in the prime lending rate of United States commercial banks. A more restrained tone developed toward the end of the month, but yields on Treasury notes and bonds were down over the month as a whole by ap proximately 20 basis points in the three- to five-year maturity area and by 15 basis points in the long-term area. As a result, yields for most coupon issues reached their lowest levels since late in 1965. A good demand was evident in the markets for corporate and tax-exempt bonds in January. The relatively heavy volume of new flotations was readily absorbed, and prices of new and seasoned bonds continued to advance during most of the period. In the money market, the month was highlighted by the steady downward movement of short-term interest rates, climaxed by reductions in the prime lending rate of com mercial banks announced late in the period. Treasury bill rates declined further during the month, while rates on various other short-term money market instruments— including time certificates of deposit (C /D ’s ), bankers’ ac ceptances, and commercial paper— and dealer loans were all reduced over the period. On January 30, new threemonth Treasury bills were sold at an average issuing rate of 4.486 per cent, the first time since last June that this rate was below the discount rate. While nationwide reserve avail ability expanded somewhat in January, the reserve positions of banks in the leading money centers moved into substan tial deficits in the first half of the month, partly as a re sult of a sharp rise in their loans to United States Gov ernment securities dealers. Subsequently, reserves again shifted back toward the money centers, contributing to an easier tone in the money market. THE M O N E Y M ARKET A N D BA N K RESERVES The money m arket remained comfortable in January. Most Federal funds trading took place in a 4 to SVz per cent range, compared with the 5 to 5 Vi per cent range which had predominated in December. Treasury bill rates continued to edge downward while, by the close of the month, dealers in bankers’ acceptances were quoting a 4% per cent (bid) rate on ninety-day unendorsed ac ceptances, 3A of a per cent lower than a month earlier. Offering rates on prime four- to six-month dealer-placed commercial paper declined by % of a per cent over the month to 5% per cent, while rates on various maturities of directly placed finance company paper fell by % to % of a per cent. In addition, New York City banks lowered their offering rates on large new C /D ’s from the 5Vi per cent ceiling at which such rates had held since last August. By January 25, the most frequently quoted offering rate on various maturities of new certificates had declined to 5% per cent, and some banks were posting rates as low as 5 V a per cent. In addition, the volume of C /D ’s outstanding at commercial banks expanded dramatically during the month. The reporting banks throughout the nation experienced a $2.2 billion rise in their outstanding certificates over the four weeks ended January 25, and thus had recouped by late Jan uary approximately three fourths of the dollar amount of the certificates lost from midsummer through late 1966. Nationwide reserve availability increased moderately in January from the average level in December, while aver age member bank borrowings from the Federal Reserve Banks contracted (see Table I ) . Despite the apparent easing of reserve pressures in the nation as a whole, the MONTHLY REVIEW, FEBRUARY 1967 36 Table I Table II FACTORS TENDING TO INCREASE OR DECREASE MEMBER BANK RESERVES, JANUARY 1967 RESERVE POSITIONS OF MAJOR RESERVE CITY BANKS JANUARY 1967 In millions of dollars; (4-) denotes increase, (—) decrease in excess reserves In millions of dollars Daily averages—week ended i 1 j Factors affecting basic reserve positions Changes in daily averages— week ended Jan. 25 Jan. 11 Jan. IS — 539 -f 190 — 284 — 27 Gold and foreign account ...................... — 13 + 475 Other Federal Reserve accounts (n e t)t.. + 40 + 412 — 497 — 276 — 107 4- 24 + 1° — 148 4-320 4-214 — 106 — 58 — 7 4-452 — 69 4- 46 + 239 4- 53 — 40 — 85 — 751 — 135 — 327 — 25 — 21 4-361 !i 4-1,298 — 63 — 240 — 349 — 85 4- 534 4 - 99 Jan. 4 Jan. 11 Jan. IS Jan. 25 Eight banks in New York City “ Market” factors Member bank required reserves*................. Operating transactions (subtotal) ............. Jan. 4 Net changes Factors Average of four weeks ended Jan. 25 Reserve excess or deficiency (—) * ....... 19 30 255 Less borrowings from Reserve Banks. 201 Less net interbank Federal funds 945 1,222 purchases or sales (—) ......................... 1,266 1,648 Gross purchases ................................. 426 Gross sales ......................................... 321 Equals net basic reserve surplus or deficit (—) .......................................... —1,128 -1,446 Net loans to Government securities dealers ................................... 1,210 1,114 16 3 22 22 115 — 940 1,753 812 440 1,256 815 887 1,481 594 -9 2 7 — 419 — 980 918 1,111 1,088 199 Thirty-eight banks outside New York City Direct Federal Reserve credit transactions Open market instruments Outright holdings: + 434 + 2 — 203 — 2 — 4- 42 5 — 22 4- 20 — 408 — 87 — 5 — 368 — 100 1 _ 624 — 40 — 115 — — 26 4-321 — 10 Repurchase agreements: — 152 + 17 4- 1 + 17 — 4- 109 643 4- 303 4- 9 1 + + 8 Other loans, discounts, and — 10 - - — 1 - 11 4- 307 4-348 —1,073 4- 282 - - 136 — 42 4- 263 — 539 4- 3S1 : + 63 Reserve excess or deficiency (—)* ., .. Less borrowings from Reserve Banks.. Less net interbank Federal funds purchases or sales(—) ......................... Gross purchases ................................. Gross sales ........................................ Equals net basic reserve surplus or deficit (—) .......................................... Net loans to Government securities dealers ................................... 28 232 15 187 9 82 27 396 20 224 643 1,473 831 1,467 2,024 558 1,853 2,353 501 1,398 1,932 533 1,340 1,946 606 - 8 4 6 -1,639 -1,925 -1,767 -1,5 4 4 396 849 1,040 818 776 Note: Because of rounding, figures do not necessarily add to totals. * Reserves held after all adjustments applicable to the reporting period less required reserves and carry-over reserve deficiencies. Table 111 D a ily average levels AVERAGE ISSUING RATES* AT REGULAR TREASURY BILL AUCTIONS In per cent Member bank: Total reserves, including vault cash*.......... 24.662 24,267 395 565 — 170 24,097 24,513 23,855 658 585 73 23,928 23,654 23,535 119 217 — 98 23,437 23,989 23,489 500 538 — 38 23,451 24,205§ 23,787§ 41S§ 476§ — 58§ 23,728§ Changes in Wednesday levels Weekly auction dates—January 1967 Maturities Jan. 9 Jan. 16 Jan. 23 Jan. 30 Three-month ................................. 4.818 4.716 4.680 4.486 Six-month .................................... 4.890 4.686 4.662 4.460 Monthly auction dates—November 1966-January 1967 System Account holdings of Government securities maturing in: Less than one year ...................................... More than one year..................................... Total ..................................................... — 66 4- 93 — 120 4-297 4- 204 — 66 4- 93 — 120 4- 297 4- 204 Note: Because of rounding, figures do not necessarily add to totals. * These figures are estimated, t Includes changes in Treasury currency and cash. i Includes assets denominated in foreign currencies. § Average for four weeks ended January 25. November 23 December 27 January 24 Nine-month 5.552 4.920 4.656 One-year .... 5.519 4.820 4.576 * Interest rates on bills are quoted in terms of a 360-day year, with the dis counts from par as the return on the face amount of the bills payable at maturity. Bond yield equivalents, related to the amount actually invested, would be slightly higher. FEDERAL RESERVE BANK OF NEW YORK major money m arket banks experienced steadily deep ening basic reserve deficits during the first half of the month, partly reflecting a very sharp rise in their loans to Government securities dealers. In the two weeks ended January 18, the forty-six m ajor reserve city banks had aggregate deficits averaging approximately $3 billion, the highest on record (see Table II ) . These banks were able, however, to fill the bulk of their reserve needs in the Fed eral funds market, where excess reserves were readily avail able at rates generally lower than in December. Conse quently, borrowings by these banks from their Federal Reserve Banks remained moderate during this period. In the latter part of January, the basic reserve positions of banks in the central money market— and to a much lesser extent in reserve centers outside New York— improved when the nationwide distribution of reserves shifted more in favor of the money m arket banks. TH E G O V E R N M E N T SE C U R ITIE S M A R K E T The rising trend in prices, which had prevailed in the market for Treasury notes and bonds in December, gen erally persisted in January. As the new year opened, most market participants continued to feel that, with some re laxation of monetary policy, the financial tides were shift ing and the outlook for lower interest rates was improving. Over the first third of January, prices of coupon issues fluc tuated irregularly and activity contracted as traders awaited the details of the President’s State of the Union address. During this period, the coupon sector reacted cautiously to reports (subsequently confirmed) that the Export-Im port Bank was planning to offer between $400 million and $500 million of participation certificates in February. At the same time, however, bond traders were encouraged by the excellent investor receptions being ac corded both to an offering of participation certificates by the Federal National Mortgage Association and to a large telephone company bond flotation. Prices of Treasury notes and bonds rose sharply, fol lowing the President’s January 10 State of the Union message. Although some observers foresaw strong Con gressional opposition to the President’s request for higher individual and corporate income taxes, most m arket par ticipants viewed the proposal as constructive and inter preted the President’s general remarks on interest rates as improving the price outlook for various debt instruments. As a result, price quotations for Treasury notes and bonds rose Va of a point to almost 2 full points in initial trading on January 11. Subsequently, a basically confident atmosphere per sisted in the coupon sector, but prices of notes and bonds 37 reacted unevenly to several developments. M arket senti ment was buoyed by the bullish attitudes expressed in several m arket advisory letters, by the continuation of comfortable conditions in the money market, by talk of further peace moves in Vietnam, and by news that the United States and four m ajor European nations had agreed to make cooperative efforts toward achieving lower interest rates. Activity gradually contracted, however, as partici pants awaited the terms of the Treasury’s forthcoming February refunding operation. In this environment, some caution reemerged following reports that considerable re sistance was developing in Congress to the President’s surtax proposal, and in reaction to indications in the President’s budget message that substantial public offerings of participation certificates were in prospect for fiscal 1968. From January 12 through January 25, prices of Treasury notes and bonds m aturing in five years moved irregularly while prices of longer term issues declined. Al though some profit taking on the part of dealers and in vestors appeared during this period, the underlying tone of the market remained fairly confident. On January 25, the Treasury announced the terms of its February refunding. Its offering consisted of approxi mately $5.5 billion of new 4% per cent fifteen-month notes m aturing in May 1968, priced to yield about 4.85 per cent, and $2 billion of new 4 3A per cent five-year notes maturing in February 1972 and priced to yield about 4.84 per cent. Subscription books were open only on January 30 for the new notes which will replace $2.4 billion of 3% per cent notes and $5.2 billion of 4 per cent notes coming due on February 15. The market responded quite enthusiastically to the refunding announcement and to the fact that a pre-refunding was not included. In addi tion, the subsequent news that the British bank rate had been reduced from 7 per cent to 6 V2 per cent and that the prime lending rate of most United States commercial banks had been lowered from 6 per cent to 5% per cent (one m ajor bank cut its prime rate to 5¥i per cent) con siderably strengthened m arket sentiment. In reaction, prices of intermediate- and long-term coupon issues moved sharply higher until late in January. In the closing days of the month, offerings expanded somewhat— partly re flecting sales of notes and bonds by investors switching into the new refunding issues— and prices edged lower. Over the month as a whole, prices of outstanding issues m atur ing within five years ranged from %2 to l$fe points higher, those of five- to ten-year obligations ranged from 20/h to 1%2 points higher, while quotations on longer term issues rose by 2%2 to 2 10/s2 points. (The right-hand panel of the chart illustrates the movements in yields which accom panied these price changes.) 38 MONTHLY REVIEW, FEBRUARY 1967 SELECTED INTEREST RATES* MONEY MARKET RATES November 1966-January 1967 BOND MARKET YIELDS Per cent 17.00 Yields on new public utility bonds Reoffering yield--- ►Market yield Ada -------------------------- ► • Aa o --------------- ►o 6.50 6.00 U 5.50 Aaa-rated seasoned corporate bonds \ 3-5 year Government securities 5.00 4.50 4.00 3.50 111111111111111111111 n 1111111111111111 i 1111 mh 111111111n 113.00 2 November December 1966 January 1967 9 16 23 30 November 7 14 21 28 December 1966 4 11 18 25 January 1967 Note; Data are shown for business days only. * MONEY MARKET RATES QUOTED: Daily range of rates posted by major New York City banks on new call loans (in Federal funds) secured by United States Government securities (a point indicates the absence of any range); offering rates for directly placed finance company paper; the effective rate on Federal funds (the rate most representative of the transactions executed); point from underwriting syndicate reoffering yield on a given issue to market yield on the same issue immediately after it has been released from syndicate restrictions); daily averages of yields on long-term Government securities (bonds due or callable in ten years or more) and of Government securities due in three to five years, computed on the basis of closing bid rates (quoted in terms of rate of discount) on newest outstanding three- and six-month closing bid prices; Thursday averages of yields on twenty seasoned twenty-yecr tax-exempt Treasury bills. bonds (carrying Moody’s ratings of Aaa, Aa, A, and Baa). BOND MARKET YIELDS QUOTED: Yields on new Aaa- and Aa-rated public utility bonds are plotted around a line showing daily average yields on seasoned Aaa-rated corporate bonds (arrows On February 1, the Treasury released the results of the refunding operation. Subscriptions up to $100,000 for the new notes of May 1968 will be allotted in full, while larger subscriptions will be subject to a 10 per cent allot ment (but assured of an allotment of at least $100,000 per subscription). Subscriptions up to $50,000 for the new notes of February 1972 will be allotted in full, with larger subscriptions subject to a 7 per cent allotment (but assured of a minimum allotment of at least $50,000 per subscription). All subscriptions from official and other governmental accounts were allotted in full. A confident tone was also evident in the m arket for Government agency obligations in January, and prices of most issues rose on balance during the period. F or the month as a whole, new public offerings by agencies totaled Sources: Federal Reserve Bank of New York, Board of Governors of the Federal Reserve System, Moody’s Investors Service, and The W eekly Bond Buyer. approximately $2 billion and were accorded good investor receptions. Early in the period, m arket attention focused on a $600 million public offering by the Federal National Mortgage Association of five-, ten-, and fifteen-year p ar ticipation certificates. (A n additional $500 million of cer tificates was sold directly to Treasury trust accounts.) The new participation certificates— the first to be issued since June of last year— were priced at par to yield 5.20 per cent and attracted considerable investor interest. Later in the period, the Export-Im port Bank confirmed reports that it would offer $500 million of participation certificates on February 7. In the market for Treasury bills, where yields had fallen sharply in December, rates receded further in January. During the first third of the month, bill rate declines were FEDERAL RESERVE BANK OF NEW YORK held in a narrow range. Although investment demand for Treasury bills remained fairly extensive during this period, the relatively high dealer loan rates being posted by New York City banks had some restraining effect on profes sional participants and commercial banks expanded their sales of shorter term bills. The President’s State of the Union remarks about interest rates and tax policy buoyed the bill sector, and rates fell sharply on January 11. The demand for bills subsequently expanded, dealer financing costs eased, and bill rates edged irregularly lower from January 12 through the end of the month (see the lefthand panel of the chart). At the regular monthly auction of new nine- and twelve-month bills on January 24, aver age issuing rates were set at 4.656 per cent and 4.576 per cent, respectively, 26 and 24 basis points below average rates set a month earlier (see Table HI). At the final regu lar weekly auction of the month on January 30, average issuing rates were set at 4.486 per cent for the new threemonth bills and 4.460 per cent for the new six-month issue, 34 and 45 basis points, respectively, below average rates at the comparable auction a month earlier. OTHER SE C U R ITIE S M A R K E T S In the markets for corporate and tax-exempt bonds, prices continued to advance on balance in January. (Note the comparable sharp drop in yields illustrated in the righthand panel of the chart.) Underwriters generally bid aggressively for the substantial volume of new corporate and tax-exempt bond flotations during the month. Investor interest in the new issues proved strong, with commercial bank demand for tax-exempt bonds especially significant during the period. In the corporate sector, the largest new bond offering in January consisted of $250 million of Aaa-rated 5Vi per cent American Telephone and Telegraph Company deben 39 tures that reached the market on January 10. The obliga tions, which are due to mature in 1997, carry five-year call protection. The issue, reoffered to yield 5.40 per cent, was accorded an excellent reception by investors and quickly advanced in price. The pricing of this issue was in sharp contrast to that of a comparable telephone com pany bond flotation last August, which was reoffered to yield 5.58 per cent and traded later that month at yields as high as 5.82 per cent. On January 17, a $40 million Aaa-rated power company utility issue, maturing in 1997 and carrying five-year call protection, was reoffered to yield 5.12 per cent, 28 basis points below the original reoffering yield on the January A.T.&T. issue. Later in the month, a relatively small Aa-rated utility issue, maturing in 1997 and carrying five-year call protection, was reoffered to yield 5.05 per cent and encountered some investor resistance. In the tax-exempt sector, the largest January bond flo tation consisted of $114 million of New York City variouspurpose bonds which were reoffered to yield from 3.10 per cent in 1968 to 3.90 per cent in 1997. The bonds, which were Baa-rated by Moody’s, attracted a fairly good investor interest. In October 1966, reoffering yields on a New York City bond issue ranged from 4.50 per cent to 4.60 per cent for bonds maturing in the 1968 to 1971 interval and from 4.55 per cent to 4.50 per cent for bonds maturing from 1972 to 1997. Over the month as a whole, the average yield on Moody’s seasoned Aaa-rated corporate bonds fell by 37 basis points to 5.02 per cent. The Weekly Bond Buyer’s series for twenty seasoned tax-exempt issues, carrying ratings ranging from Aaa to Baa, dropped sharply by 34 basis points to 3.43 per cent (see the right-hand panel of the chart). These indexes are, however, based on only a limited number of seasoned issues and do not necessarily reflect market movements fully, particularly in the case of new and recent issues.
@FedFRASER