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MONTHLY R E V I E W SEPTEMBER 1966 Contents Treasury and Federal Reserve Foreign Exchange Operations, by Charles A . Coombs. .. 191 The Business Situation ............................................... 199 The Money and Bond Markets in August .............. 203 Federal Reserve System Policy Statement ............ 209 FEDERAL RESERVE BANK OF NEW YORK 191 T reasu ry and Federal R eserve Foreign Exchange Operations* By C ha r les A. C o o m bs During the past six months, the international financial system was again subjected to considerable buffeting, particularly during the first three weeks of July when speculation against sterling reached major proportions. The impact of these pressures was cushioned, however, by use of the Federal Reserve reciprocal currency network and other central bank credit arrangements which, in the case of sterling, provided the time needed by the British Government to plan and put into effect the sweeping cor rective program announced on July 20. By late August, the sterling and other exchange markets had settled down to reasonably well-balanced and orderly trading but in an atmosphere of continuing anxiety. Against this background of market uncertainty, the Federal Reserve broadened out earlier discussions of in creases in several of the swap lines to negotiation of a general expansion of virtually the entire network. The gen eral objective of these negotiations was to increase the reciprocal credit facilities available, both to the Federal Reserve and to its central bank partners, to levels well above the size of any routine drawings that might rea sonably be expected and thus to create a broad margin of safety against any unforeseeable threats to international currency stability. As a result of these negotiations, the Federal Reserve swap network has been enlarged from $2.8 billion to $4.5 billion. Partly due to the backwash of the speculative pressures on sterling and partly reflecting seasonal payments pat terns, the Federal Reserve made several drawings on the reciprocal currency lines during July and August in order to absorb flows of dollars to certain continental European central banks. A total of $150 million equivalent of Swiss francs was drawn in July under the arrangements with the Swiss National Bank and the Bank for International Set tlements (BIS); drawings also were made under the arrangements with the Netherlands Bank in the amount of $65 million equivalent, with the National Bank of Belgium for $30 million equivalent, and with the Bank of Italy for $225 million equivalent. In late August the entire Table I FED ER AL RESERVE RECIPROCAL CUR R EN C Y A R R ANG EM ENTS A N D COMMITMENTS Amount of facility Institution February 28, 1966 September 15, 1966 System commitments August 31, 1966 in millions of dollars equivalent Austrian National Bank ......................... 50 100 National Bank of Belgium ................. 100 150 Bank of Canada ...................................... 250 500 Bank of England ...................................... 750 1,350 Bank of France ........................................ 100 100 German Federal Bank ........................... 250 400 20 600 250 450 Netherlands Bank .................................... 100 150 Bank of S w e d e n ........................................ 50 100 Swiss National B a n k ............................... 450 Bank of Japan .......................................... * This is the ninth in a series of reports by the Vice President in charge of the Foreign function of the Federal Reserve Bank of New York and Special Manager, System Open Market Account. The Bank acts as agent for both the Treasury and the Federal Re serve System in the conduct of foreign exchange operations. Bank of Italy ............................................ 150 200 75 Bank for International Settlements. .. 300* 400* 75 Total ................................................ 2,800 4,500 65 235 * H all is available in Swiss francs and half in other European currencies. 192 MONTHLY REVIEW, SEPTEMBER 1966 Table II O U T ST A N D IN G U N IT E D STATES TR EA SU R Y SECURITIES FO REIGN CUR R EN C Y SERIES In millions o f dollars equivalent Issued to Amount out standing January 1, 1966 Austrian National Bank....... 1 II JulyAugust — 25.2 100.7 N ational Bank o f Belgium.... Redemptions— 1966 75.5* 30.2 German Federal Bank ....... 602.1 Bank o f Italy ......................... 30.2 — 100.6 — 50.3 349.5 — 23.2 257.3 — 100.6 — 23.0 211.1 — 148.9 — 73.3 883.8 124.8 Swiss N ational Bank............ Bank for International Settlem entsf ............................. 1,207.8 124.8 92.6 Total ...................................... Amount out standing August 31, 1966 92.6 — 100.6 Note: D iscrepancies in amounts are due to valuation adjustments and rounding. * $25.2 million equivalent redeemed September 6. f Denominated in Swiss francs. drawing on the Bank of Italy was repaid from a United States drawing of lire from the International Monetary Fund (IM F), and a repayment of $10 million was made on the drawing from the National Bank of Belgium. As of August 31, therefore, the total outstanding drawings by the Federal Reserve amounted to $235 million. During the course of the late spring and summer months, the Bank of England drew on the swap line with the Federal Reserve, and $300 million remained outstand ing as of August 31. With the increase in the Federal Reserve-Bank of England facility to $1,350 million, there thus remains available to Britain somewhat more than $1 billion of unused credit facilities under this arrangement. Moreover, on September 13 the Bank of England an nounced the negotiation of new facilities with other cen tral banks. Apart from the new facilities the Bank of England still has at its disposal important unused facilities arranged previously. Finally, in August the BIS drew $75 million from the Federal Reserve under the recipro cal credit facility providing for drawings against Euro pean currencies other than Swiss francs. In April and May, before the exchange markets became disturbed by flows of volatile funds, the United States Treasury also made further substantial progress in retiring outstanding obligations in the foreign currency series. Beginning in the summer of 1965, a good start had been made in repaying German mark-denominated obligations of the Treasury as the German balance of payments moved into deficit, and further progress continued through July 1 by which time the total mark obligations outstand ing had been reduced from a peak of $679 million to $350 million. In addition, opportunities appeared to acquire Swiss francs and Austrian schillings, and repayments of $46 million of Swiss franc securities and $50 million of Austrian schilling securities were effected. As a result, such Treasury foreign currency obligations were reduced on balance by $400.2 million equivalent from the peak of $1,259.1 million in July 1965 to $858.9 million equiva lent on September 6, 1966. Since the Treasury regards such foreign currency obligations only as a means of fi nancing temporary balance-of-payments deficits, it natu rally takes advantage of every market opportunity to retire such obligations at maturity or, in certain circumstances, to effect repayment in advance of maturity. During the period under review, the Bank of Italy con tinued its cooperative efforts to minimize the impact on world financial markets of Italy’s heavy balance-ofpayments surplus. As previously noted, the Federal Re serve made drawings of $225 million in Italian lire on the swap line of the Bank of Italy in July and early Au gust, and this swap drawing was liquidated in August. The lire needed to repay the Bank of Italy were acquired by a United States Treasury drawing of $250 million equiva lent of lire from the IMF. In order to insure that the Fund’s supply of lire would be adequate to finance such a United States drawing, the IMF, whose regular lira hold ings were at a low level, arranged to borrow from Italy the lire needed for the United States drawing. This trans action was of material benefit to the United States and Italy and demonstrates the flexible manner in which the Fund can assist reserve currency countries as well as other countries in financing their balance-of-payments surpluses and deficits. ST E R LIN G Sterling enjoyed a six-month period of recovery, follow ing the announcement of new international support for the pound on September 10, 1965. As dollars flowed back to the Bank of England between September and February 1966, the bank repaid in its entirety $890 million in short term credit received from the Federal Reserve and the United States Treasury and, in addition, succeeded in liquidating a substantial part of its forward exchange commitments. Beginning in late February, however, ster ling began to weaken once again, and by July the pressures had reached crisis proportions. Indeed, even when the British Government reacted to the massive attack on the pound by announcing on July 20 a profound and farreaching austerity program, the exchange markets were FEDERAL RESERVE BANK OF NEW YORK so demoralized after two years of almost continuous tension that there was no immediate recovery in sterling. To be sure, the intense selling wave was stemmed, but market sentiment remained extremely cautious and after a brief upward surge the sterling rate again declined. By early September, however, there was evidence that the British Government’s determination to defend sterling would receive broad public support and that the program was already beginning to show results. At the end of February the sterling rate moved be low par for the first time since September 1965, as the exchange markets became more cautious in view of the disappointing January trade results and the impending British general election scheduled for late March. These uncertainties were reflected particularly in a reduced volume of sterling trading and an increased vulnerability of the spot rate to any downward pressures. When the sterling rate dropped very sharply on March 9, to $2.7930, the Federal Reserve entered the market with heavy bids for sterling. This reminder of continued United States official support quickly reassured the mar ket, and sterling rebounded to about $2.7960 on the following day. Over succeeding weeks, however, the pound again eased, as the uncertainties generated by the approaching election were reinforced by an increasing stringency in the Euro-dollar market— a development that was to intensify in coming months and exert recurrent pressure on sterling as funds flowed from London. The Labor Party’s decisive victory at the polls on March 30 produced little reaction in the exchange markets since this result had long been anticipated. Indeed, the markets remained relatively quiet throughout April, await ing Chancellor Callaghan’s new budget. When the budget was announced, however, the market interpreted it as being only moderately restrictive, with the principal pro visions not taking effect until the fall, and initially there was some selling of sterling. With support from both the Bank of England and this Bank, the market soon re gained its equilibrium, but it remained vulnerable to any new setbacks. In this atmosphere, the outbreak of the British seamen’s strike in mid-May was a devastating blow. Sterling quickly declined to about $2.7900 in heavy trading and, as the strike dragged on, the market became increasingly apprehensive. The announcement of a large reserve de cline in May heightened the general tension, and the first of a series of intensive and prolonged selling waves began on June 3. Relief from these pressures was provided temporarily by the announcement in mid-June that the short-term credits from European central banks which had formed part of the September 1965 arrangements in 193 support of the pound had now been placed on a continuing basis, this time including French participation. The Fed eral Reserve and United States Treasury participation in the September 1965 arrangements continues to be avail able to the United Kingdom alongside these other facilities. The respite for sterling provided by the announcement of this arrangement was short-lived, however, as increas ing stringency in the Euro-dollar market left British interest rates not fully competitive, with consequent outflows from London in late June. While spot sterling came under pressure, forward sterling quotations narrowed and a sizable arbitrage incentive in favor of the United Kingdom developed in relation to short-term instruments in the New York market. Consequently, the Federal Reserve Bank of New York, with the agreement of the Bank of England, undertook market swap transactions in which, for System and Treasury accounts, it bought a total of $66.6 million equivalent of sterling spot and sold it for delivery onemonth forward. This operation both reduced the arbitrage incentive to shift funds from New York and at the same time eased exchange market pressures and bolstered spot sterling quotations. As the maritime strike continued and the situation in Rhodesia remained unresolved, market sentiment steadily deteriorated. Despite a 9 per cent rise in exports in the five months prior to the outbreak of the strike, the United Kingdom’s trade account had not improved significantly over the corresponding months of 1965 as import demand had remained abnormally high. Moreover, the figures re leased at the end of June indicated that in the preceding four months, British reserves had declined $372 million, even after recourse to central bank assistance. In addition, uneasiness was heightened by evidence of dispute within the Labor Party over the proposed tightening of the incomes policy, an important element in the long-term resolution of Great Britain’s payments difficulties. The resignation from the government of Mr. Frank Cousins, a veteran trade union leader, proved particularly disturbing to market confidence. Selling pressures on sterling intensified, reaching very heavy proportions in mid-July. In the face of these sales, the Bank of England continued to provide firm support for the pound in both spot and forward markets, and on July 14 raised its discount rate from 6 per cent to 7 per cent and doubled the special deposits required of the London and Scottish banks. The market, however, shrugged off the bank rate increase as merely a technical adjustment to rising interest rate levels abroad. That same afternoon Prime Minister Wilson, in speaking to Par liament, confirmed that Britain was faced with a new financial crisis and warned that additional measures would 194 MONTHLY REVIEW, SEPTEMBER 1966 be taken by the government. As tension mounted, ster early March, when the Swiss franc fell to $0.2304Vs, the ling was heavily sold in both the spot and forward mar Swiss National Bank sold dollars to moderate the rate kets, but determined resistance by the Bank of England decline and replenished its dollar holdings by selling Swiss prevented the market situation from getting out of hand. francs to the Federal Reserve and United States Treasury. From February through early April, the United States Against this background, the British Government on July 20 introduced a massive austerity program that called authorities bought a total of $118 million equivalent of for a wage freeze, restraint on prices and dividends, addi Swiss francs. With these francs, the Federal Reserve tional taxes, reduced travel allowances, and further curbs System fully repaid its $40 million equivalent German on public expenditures both at home and overseas. The mark-Swiss franc swap with the BIS, while the United new program clearly strikes at the problem of excessive States Treasury liquidated a similar swap for $15 mil domestic demand and, given adequate time, should prove lion equivalent (see this Review, March 1966). The effective. Reflecting the confidence of the United States System temporarily added $46 million equivalent to its Government that the British program could accomplish its Swiss franc balances, simultaneously selling these Swiss objectives, the Federal Reserve moved into the sterling francs forward to the Treasury for delivery on May 16 and market shortly after the British Government’s announce July 20, on which dates the Treasury repaid at maturity ment on July 20 in order to stem, and if possible reverse, two Swiss franc-denominated securities issued to the Swiss the drain on the Bank of England’s reserves. By July 22, National Bank as fiscal agent for the Swiss Confederation. the sterling rate had recovered from $2.7866 immediately (These repayments reduced the amount of such commit before announcement of the new program to a level above ments from $349.9 million to $303.7 million equivalent.) At the same time, the Treasury added $17 million equiv $2.7900. In the final week of July and the beginning of August, alent to its Swiss franc balances. In addition, the Treasury the sterling rate held fairly steady, but no vigorous recovery purchased $18 million in gold from the Swiss authorities. developed as the market waited to see whether the British During April, monetary conditions in Switzerland tight Government would succeed in carrying through so drastic ened and the Swiss franc began to strengthen. When the a program. Indeed, sterling remained vulnerable to down rate reached its effective ceiling of $0.2317^ in early ward pressures throughout the month of August and, as May, the Swiss National Bank entered the market as a yields on dollar-denominated investments rose rapidly, buyer of dollars for the first time since the beginning of the exerting a strong pull on funds from London, the spot year. The franc remained at the ceiling in subsequent weeks sterling rate declined to $2.7880 while forward sterling as the Swiss banking community began to repatriate funds discounts narrowed very sharply to under 1 per cent. to meet midyear liquidity needs and as foreigners who had Nevertheless, there is already evidence that the British Gov previously borrowed Swiss francs switched to less costly ernment’s new program has begun to take hold at the same Euro-currencies, paying off their Swiss franc borrowings time that the measures introduced in the April budget with outright purchases of francs. At the same time, are also taking effect. Even before the full effect of these mounting pressures on sterling added further to the de corrective measures is felt, the technical position of ster mand for Swiss francs. Consequently, during May and ling, which has been grossly oversold in recent months, June the Swiss National Bank took in $200 million should bring about a strong recovery of the sterling rate. through outright purchases, and an additional $82 million In the meanwhile, with the reinforcement of the Bank in short-term swaps with Swiss commercial banks to help of England’s credit lines that has now taken place with the provide for their temporary midyear requirements. Federal Reserve and other central banks, the Bank clearly By July, uncertainties generated by the pressures on has ample resources to deal with any temporary specula sterling again dominated the foreign exchange markets, tive flurries that might otherwise impede the progress of and the usual reflux of funds from Switzerland following the midyear window-dressing date was sharply reduced. recovery. Moreover, as some additional funds gravitated to the coun try, the franc remained at or close to its ceiling. Accord S W ISS FRANC ingly, in July the Federal Reserve reactivated its swap The Swiss franc declined steadily during the first quar facilities with the Swiss National Bank and with the BIS, ter of 1966 as a result of seasonal influences, sizable out drawing $75 million of francs from each bank to absorb flows of capital induced by easy monetary conditions in uncovered dollars from the Swiss central bank. In addition, the Swiss market, rising Euro-dollar rates, and attrac the Swiss authorities purchased $20 million of gold from tive yields on offshore United States corporate issues. In the United States Treasury. Thereafter, however, pressures 195 FEDERAL RESERVE BANK OF NEW YORK on sterling subsided somewhat, and with yields on dollar investments moving higher during late July and August, funds once more began to flow out of Switzerland, and the franc eased well below its ceiling. GERM AN MARK The deficit that had emerged in the German balance of payments during 1965 continued at a reduced rate in early 1966. In the first five months of this year official German reserves declined $310 million (exclusive of a payment on its increased IMF quota), reflecting short term outflows of funds attracted by higher Euro-dollar rates, and rising net overseas expenditures for services. Consequently, during this period the mark was generally on offer at rates somewhat below the parity of $0.2500. The ready availability of German marks enabled United States monetary authorities to continue purchasing marks — as they had since June 1965— in order to repay medium-term mark-denominated United States Treasury indebtedness to the German Federal Bank. By March 1, 1966 some $175 million equivalent of such obligations had been repaid (see this Review, March 1966). In the next four months a total of $117 million equivalent of marks was purchased for Treasury account, mostly in the New York market. The Treasury used these marks, together with balances on hand, to redeem at their respective maturities on April 1, June 1, and July 1 an additional $150 million equivalent of mark-denominated securities held by the German Federal Bank. Thus in the course of twelve months ended in mid-1966 the Treasury had re duced its mark-denominated indebtedness by $326 million to $350 million equivalent. The German Federal Bank had been pursuing a gen erally more restrictive monetary policy throughout 1966, and on May 26, in line with this policy, it announced an increase in its discount rate to 5 per cent from 4 per cent. With large tax payments also falling due in June, the German money market tightened toward midyear. This factor, together with increasing pressures on sterling, the usual midyear window-dressing operations, and the beginnings of a recovery in the German trade position following a sharp deterioration in 1965, contributed to re newed demand for marks. By late June the spot mark had risen to parity. The further worsening in the sterling situ ation and the continued improvement in Germany’s trade account imparted additional strength to the mark in July, and by the end of that month official German reserves were $391 million higher than at the end of May. More balanced conditions emerged in the exchanges in August, however, and mark quotations steadied at about $0.2506. IT A L IA N LIR A Italy continued to register a substantial balance-ofpayments surplus during the first eight months of 1966. The surplus was smaller than a year earlier, however, partly because of a wider trade deficit but mainly because of a sizable outflow of long-term capital attracted by the high yields available in the international bond market. In addition, Italian commercial banks once again began supplying fairly important amounts of short-term funds to the Euro-dollar market in the early months of the year. These short-term outflows offset the overall surplus and Italian official reserves actually changed little during the first half-year. At the beginning of 1966, the Federal Reserve had out standing a drawing of $100 million under its swap ar rangement with the Bank of Italy. In February, this draw ing was liquidated using $50 million equivalent of lire purchased in a special transaction with a foreign central bank and $50 million acquired through a sterling-lira swap with the BIS. In March and May, there were occasionally small offerings of lire in the New York market and the Federal Reserve purchased a total of $10 million equiva lent. These lire were used on May 25 to reduce the thirdcurrency swap with the BIS from $50 million to $40 million equivalent. In June, demand for lire began to rise as Italy’s tourist season moved into full swing. By this time, moreover, most Italian banks had already eliminated any net liability position vis-a-vis foreigners, and in these circum stances the Bank of Italy was no longer prepared to shift dollars abroad through short-term swaps with those com mercial banks at preferential rates. As a result, the Italian payments surplus was increasingly reflected in the growth of official reserves, which rose rapidly during the summer months. Accordingly, the Federal Reserve reactivated its $450 million swap facility with the Bank of Italy in July and early August, absorbing a total of $225 million from the Italian authorities. These drawings under the swap arrangement were liquidated through a United States drawing of $250 million equivalent of lire from the IMF on August 22. The lire drawn from the Fund were sold by the United States Treasury to the Federal Reserve, which in turn used $225 million equivalent to repay in full its swap commitment to the Bank of Italy. The re maining $25 million equivalent, plus $1 million of existing lira balances, was used to reduce to $14 million the sterling-lira swap with the BIS. Federal Reserve and Trea sury technical forward commitments in Italian lire, under taken in 1965, remained unchanged during the period covered by this report. 196 MONTHLY REVIEW, SEPTEMBER 1966 B E LG IA N FR A N C The Belgian franc traded below its ceiling during the first half of 1966, as the sizable current account surplus of the previous year gave way to a small deficit. In the late spring, however, as credit policy in Belgium tightened and the money market firmed, the spot franc rate began to strengthen. The National Bank of Belgium moved to reinforce its existing measures of restraint by raising its discount rate by V2 percentage point to 5V4 per cent on June 2. Nevertheless, official reserve gains remained small until July and August, when funds were repatriated as a result both of the domestic liquidity squeeze and the speculative pressure on sterling. The spot franc rate moved to its ceiling in late July, and the National Bank began purchasing fairly sizable amounts of dollars. In order to absorb some of the rapid increase in Bel gium’s holdings of dollars, the Federal Reserve in August reactivated the $50 million standby portion of its $100 million swap facility with the National Bank of Belgium and purchased a total of $30 million from the Belgian authorities. Later in August, however, the Belgian money market eased and funds once again began flowing abroad in response to higher dollar investment rates. The National Bank then began supplying foreign exchange to the mar ket and covering these losses by purchasing dollars from the Federal Reserve. Thus, by the end of the month the System was able to reduce its short position in Belgian francs to $20 million equivalent. further in early August, and the Federal Reserve reactivated its $100 million swap facility with the Netherlands Bank, drawing a total of $65 million of guilders and using them, together with $2.5 million of guilder balances, to absorb an equivalent amount of dollars. By mid-August, however, the Dutch money market had eased and, as increasingly attractive interest rates on dollar investments were exert ing a pull on Dutch funds, there was no further need for System operations in guilders. A U S T R IA N S C H ILLIN G Austria’s international reserves decreased in late 1965 and early 1966, as a consequence of a weakening in the Austrian balance of payments. In order to meet this de velopment, the Austrian National Bank in April sold to the United States Treasury $25 million of Austrian schillings and the Treasury used these schillings to repay at maturity an Austrian schilling-denominated Treasury bond. Aus tria’s overall payments position then improved, and through the early summer months the Austrian National Bank was able to add somewhat to its reserves. In late August, how ever, there was again an outflow of funds from Austria, and official reserves declined. Once again, this provided an opportunity for the Treasury to acquire Austrian schillings, and on September 6 the Treasury paid off another $25 million equivalent Austrian schilling-denominated bond, thereby reducing its total schilling-denominated indebted ness to $50 million equivalent. D U TCH G U ILD E R C A N A D IA N DOLLAR The Dutch guilder was generally on offer during the first four months of the year, as both seasonal weakness and some special factors contributed to a widening in the Netherlands trade deficit. Occasionally, tight money mar ket conditions in Amsterdam induced inflows of short term funds which temporarily offset the downward pres sure on the guilder rate, but on balance quotations eased noticeably. As early as January, the guilder was quoted below par, and by late April it had reached the lowest level since the revaluation of March 1961. Effective May 2, the Netherlands Bank raised its dis count rate to 5 per cent from AV2 per cent in order to curb the growth of domestic bank credit and stem the deteriora tion of the Dutch balance of payments. The guilder im mediately rallied and then continued to rise, reaching par by early June. After midyear, increasingly tight money market conditions in Amsterdam and growing tensions in the sterling market led to a sizable inflow of funds. As a re sult, Dutch reserves increased $94 million in July and rose Movements in the Canadian dollar rate during the early months of the year were significantly influenced by fluc tuations in the volume of new Canadian securities offer ings in New York. At the same time, seasonal weakness in the trade account and Canadian government purchases of about $110 million of United States-held Canadian gov ernment debt resulted in a decline of $323 million in Canada’s official gold and dollar reserves during the first half of the year (after payment of $47 million to the IMF in connection with its quota increase). About midJune, however, the return of seasonal strength in Canada’s external accounts, announcements of some fairly sizable new securities sales in New York, and conversions of sterling by Canadian exporters as the pound came under increased pressure, led to a firming of the Canadian dollar rate. Moreover, the announcement on June 20 of a new Canadian-Russian wheat agreement, providing for ship ments to Russia of $740 million of wheat over three years, helped sustain market demand. Official reserves never FEDERAL RESERVE BANK OF NEW YORK theless declined once again because of additional official purchases on July 2 of $31 million of United States-held Canadian Treasury securities. Canadian dollars also were actively sought in the for ward market during much of the period as a result of covered conversions by Canadian banks of domestic time deposits into United States dollar investments. In early summer, this demand was reinforced by intermittent buy ing by grain interests and by exporters hedging future sterling receipts. The latter activity subsided later in Au gust, however, when an easier tone also reappeared in the spot market, with quotations fluctuating narrowly just below $0.9300. There were no Federal Reserve or Trea sury operations in Canadian dollars during the period except for those relating to IMF transactions described below. OTHER C UR R E N CIE S There have been no official United States transactions in French francs, Japanese yen, or Swedish kronor this year. IN T E R N A T IO N A L M O N E T A R Y F U ND During the period under review, the United States made two separate types of drawings on the IMF. The first, designated “technical”, extended the practice initiated in February 1964 of obtaining currencies from the IMF for sale to other countries making repayments to the Fund (see this Review, October 1965, page 208, for a detailed explanation of this type of operation). The United States Treasury, between March and August, arranged for draw ings totaling $300 million equivalent of Canadian dol lars. Whereas earlier the facilities were drawn on in their entirety at their inception, under the current arrangements drawings are made periodically as needed. The second type of drawing was of the more conven tional type in which member countries obtain currencies for use directly in the financing of their international pay ments deficits. The United States first had recourse to the Fund in this manner in July 1965, when it made a multicurrency drawing equivalent to $300 million and used most of the drawing to fund earlier short-term credits. On August 22, 1966, the Treasury again went to the Fund for this purpose, drawing $250 million equivalent of Italian lire and subsequently selling the lire to the Federal Reserve for liquidation of its $225 million equiv alent swap commitment to the Bank of Italy and a partial repayment of a sterling-lira swap with the BIS. The Fund, whose lira balances were at a low level, borrowed the 197 required lire from the Italian government under an agree ment lying outside the $6 billion General Arrangements to Borrow (G.A.B.). This was the first occasion on which the IMF had employed its authority under the articles of agreement to borrow needed currency from a member country other than under the G.A.B., and it marked an other significant step in the evolution of the Fund credit machinery. United States drawings from the Fund between Febru ary 1964 and August 1966 have totaled $1,532 million. At the same time, other countries have drawn dollars from the Fund, thereby reducing the Fund’s holdings of dollars in excess of 75 per cent of the United States quota and thus reducing this country’s repayment obligation to the Fund. Consequently, at the end of August 1966 net United States indebtedness to the Fund was only $893 million. The vital role that the IMF plays in the international financial mechanism was greatly reinforced last February when a general Fund quota increase of 25 per cent or more, adopted in 1964 by the Governors of the Fund, became effective for 58 members who had accepted the proposal and whose combined quotas as of February 23, 1965 constituted the requisite two-thirds majority for ap proval. By August 31, an additional 32 members had sub mitted their ratification, and Fund resources had been increased from $16 billion to $20.6 billion, or close to the ultimate $21 billion target for the Fund’s entire 104 nation membership. The quota increases must be paid to the Fund partly in a member’s own currency and partly in gold. Such gold payments, however, have entailed gold losses for the two key currency countries, the United States and the United Kingdom, as other members have converted dollars and sterling into gold for payment of their gold subscription. In order to compensate for these losses, the quota increase arrangement provides that the Fund will deposit a total of up to $350 million of gold with the Federal Reserve Bank of New York and the Bank of England. Insofar as the United States is con cerned, these compensating operations began in Septem ber 1965 and as of August 31 the Federal Reserve Bank of New York held for United States Treasury account $202.7 million of gold so deposited by the IMF. The gold is reflected in the Federal Reserve’s statement of condition under “other assets” and the deposit liability under “other deposits”. GOLD M ARKET DEVELOPM ENTS The price of gold in the London market has ranged between $35.11 and $35.1940 during the first eight 198 MONTHLY REVIEW, SEPTEMBER 1966 Table III U N IT E D STATES N E T M ONETARY GOLD TRANSACTIONS W ITH FO REIG N COUNTRIES A N D INTER N A TIO N A L INSTITUTIONS* January-June 1966 In m illions o f dollars at $35 per fine troy ounce; U nited States net sales (—), net purchases (+ ) Country Canada .............................................................. + 100.0 Colombia ......................................................... + Second quarter First quarter + 50.0 7.0 France .............................................................. - 102.8 Lebanon _ 10.8 ......................................................... — 220.7 Switzerland ..................................................... + 7.0 + United Kingdom .......................................... - 19.0 - 7.2 A ll other ......................................................... - 15.6 - 0.4 N et sales ................................................. - 34.0 - 167.3 11.0 Note: Because of rounding, figures do not necessarily add to totals. * N ot reflected in this table are United States monetary gold transactions with foreign countries mitigated through special deposits by the IMF. months of this year, with upward pressures on the price predominating during much of the period. The underlying supply-demand relationship in the market has been quite different this year, however, from the same period a year ago when similar price pressures prevailed. Private de mand for gold this year has remained well below last year’s levels, no doubt reflecting in part the much more attractive interest yields this year as a result of tightening credit conditions in many countries. On the other hand, the supply of gold coming on the market has also been considerably reduced from last year, primarily because of the shift in South Africa’s balance-of-payments posi tion. Whereas during the first seven months of 1965 South African gold reserves declined by $213 million, adding roughly that much to the supplies available from new production for sale in London, during the same pe riod this year South African gold reserves have increased by $250 million, with consequent reduction of the amount of new production available for sale. As a result of this swing in South Africa’s payments position and re serves, therefore, there has been a temporary decline of about $500 million in gold coming on the London mar ket from this source. Moreover, there have been no Russian sales of gold during the first eight months of this year. Over coming months there is a reasonable likelihood that the flow of gold to the London market will return to more normal levels. FEDERAL RESERVE BANK OF NEW YORK 199 The B usiness Situation Recent economic developments have underscored the basic strength and momentum of the business expansion. At the same time, however, it is becoming increasingly clear that inflationary pressures are continuing to intensify. In view of the critical importance of price stability in achieving long-term economic growth and the urgent need to maintain and improve our international competitive position, it is evident that inflation has again become one of the nation’s most pressing economic problems. Industrial output climbed strongly in July, and the large and rising backlog of orders in manufacturing provides a basis for further growth of production in the months ahead. The strength of consumer demand was clearly demonstrated by a further advance in retail sales in July, following the sharp June recovery, and by a recent survey of consumer buying intentions indicating that overall plans to purchase major durable goods remain well above the high year-ago level. Business spending on productive facilities continues at the rapid pace forecast earlier in the year, and a recent survey by the National Industrial Conference Board shows that appropriations for capital expansion by large manufac turing firms moved up sharply in the second quarter. Out lays for inventories by manufacturing firms also continue to increase strongly. While Federal defense spending remains one of the most uncertain elements in the outlook for ag gregate demand, the buildup of military forces already in process is likely to result in a continued sharp uptrend in defense spending well into 1967. Residential construction continues to be the only major sector of the economy exhibiting significant weakness. Hous ing starts have declined steadily since the beginning of the year. Other types of construction remain strong, however, especially industrial and public building. Thus, while em ployment in residential construction has eased in certain regions, some of the resources released by the decline in residential construction are being absorbed into other types of building activity. Moreover, residential building should be stimulated by the implementation of pending legislation designed to increase the mortgage purchase and lending authority of the Federal National Mortgage Asso ciation by as much as $4.7 billion. In the face of tight labor markets and high-level utiliza tion of production facilities, the price level continues to reflect demand pressures. Consumer prices again rose sharply in July, while at the wholesale level prices of farm products and processed foods moved upward substantially, following several months of declines. Industrial wholesale prices also increased further, although at a pace slower than in the first half of the year. Furthermore, the recent rise in consumer prices— notably the prices of food and services— has added to the wage demands now being pressed in collective bargaining. Management may find it hard to resist these demands in view of the high level of profits and substantial backlogs of orders. Indeed, the settle ment recently concluded in the airline strike, apparently calling for annual increases in wages and fringe benefits more than half again as large as the Administration’s 3.2 per cent guideline for noninflationary wage increases, underscores the developing dangers of cost inflation. PR O D U C T IO N , O RDERS, A N D B A C K L O G S The Federal Reserve Board’s seasonally adjusted index of industrial production advanced by a substantial 1.3 per centage points in July to 157.5 per cent of its 1957-59 average, despite a 10 per cent decline in the output of automobiles. Excluding the automotive component of the index, industrial production climbed 1.8 percentage points for the largest monthly advance since February. The July gain in total production included a substantial further expansion in the output of defense materials and business equipment, reflecting the continuing military buildup and the persistent growth of business capital spending. Increases in output were also widespread among producers of both durable and nondurable industrial ma terials. Output of iron and steel turned up after a twomonth decline, and new orders booked by steel mills for September and October show increases among a wide range of users, including automobile manufacturers. Among the other major market groupings in the indus trial production index, the output of finished consumer goods remained roughly unchanged as declines in automo biles and some other major durable goods were offset by increases in the production of consumer nondurables. The 200 MONTHLY REVIEW, SEPTEMBER 1966 recent slowdown in the output of consumer durables may well have been a delayed reaction to the spring decline in retail sales of these items, and it should be noted that retail sales have since rebounded strongly. The July advance in manufacturing production was at a seasonally adjusted annual rate of 10 per cent, somewhat above the average rate of expansion of manufacturing capacity indicated for 1966 as a whole by the spring McGraw-Hill survey. The average capacity utilization rate is already at 93 per cent for manufacturing firms, and a continued gain in production on the order of July’s per formance would be likely to place considerable further strain on the nation’s productive facilities. Recent data on new orders suggest continued strong advances in industrial production. New orders received by manufacturers of durable goods in the second quarter rose to a record seasonally adjusted quarterly average of well over $24 billion (see Chart I). New orders in July were down slightly from this level, as decreases in automobile and aircraft orders more than offset advances in other in dustry groups. However, the volume of new bookings re mained well above the July rate of shipments, and back logs of unfilled orders piled up further among a wide range of durables industry groups. The total order backlog has risen sharply and steadily since early 1964, following a period of more moderate growth earlier in the expansion. The ratio of unfilled orders to shipments of durables (also shown on the chart) is now at its highest level since No vember 1959, with the present backlog equivalent to more than three months of shipments at the current rate. The figures on total unfilled orders and total shipments of durables manufacturers have been subdivided into fourteen industry groups and an “all other” category. These industry data are useful in assessing the extent to which order backlogs are concentrated within or diffused throughout the durables manufacturing sector. The bot tom panel of Chart I depicts the proportion of the fifteen industry groups that in any given month had unfilledorders-to-shipments ratios above those six months earlier. This chart shows that the recent advance has been very widespread indeed. Whereas the proportion of industries experiencing increases in their unfilled-orders-to-shipments ratios fluctuated widely during 1962 and 1963, the pro portion passed the 50 per cent mark at the beginning of 1964 and trended upward thereafter. July data indicate that the ratio of backlog to shipments in thirteen of the fifteen component categories is higher than it was six months earlier. Thus, in contrast to earlier years of the current expansion when the existence of relatively low order backlogs and a sizable margin of unutilized capacity enabled durable goods Chart I INDICATORS OF DURABLES MANUFACTURERS’ ACTIVITY Billions of doiiars 80 Billions of dollars 80 NEW AND UNFILLED ORDERS OF DURABLES MANUFACTURERS * RATIO OF UNFILLED ORDERS TO SHIPMENTS OF DURABLES MANUFACTURERS * 3.0 2.8 2.6 2.4 Per cent 100 80 60 40 DIFFUSION INDEX: SIX-MONTH SPAN _ 20 UNFILLED ORDERS TO SHIPMENTS-15 INDUSTRIES t i 11 11111 111 U. 1111111111111.11 11 i 11.11I I 1111111111111 M 1» 11 i l . 1962 1963 1964 1965 1966 * Quarterly averages of seasonally adjusted monthly data. + This index expresses the percentage of the fifteen component industries that have highei ratios of unfilled orders to shipments than they did six months earlier. Source: United States Department of Commerce, Bureau of the Census. producers to accommodate increases in orders without sub stantial increases in delivery times, over the past two and a half years the proportion of firms operating at or near pre ferred capacity rates has risen markedly and order back logs have grown substantially. This situation threatens to lead to greater price pressures, production bottlenecks, and shifting of orders to foreign producers than has been the case in the past. CONSUMER DEMAND Preliminary data indicate that retail sales (seasonally adjusted) rose 0.6 per cent in July, reaching an annual rate of $306 billion, only $300 million below the record set in March (see Chart II). This advance followed a sharp re 201 FEDERAL RESERVE BANK OF NEW YORK covery in June which, on the basis of upward revised data, came to 3.6 per cent. Much of the pickup in June was attributable to increased purchases of automobiles follow ing the April and May slump, while slightly more of the July advance was accounted for by other consumer du rables. Although a part of the recent increase in retail sales reflects higher prices on many items, especially food, it nonetheless appears that real demand has increased also. Much of the adjustment of consumer spending to earlier in creases in social security taxes and higher withholding rates has probably already been accomplished, and consumer buying is now moving more closely in line with the rising trend in personal incomes. Total personal income rose strongly in July as Federal pay increases went into effect. The advance in wages and salaries was the largest since February, and would have been even greater but for the earlier than usual shutdown for model changeovers in the automobile industry and the machinist strike at some airlines. Per cent Per cent Note: Buying plans are expressed as the ratio of the number of families who indicate Chart li DISPOSABLE PERSONAL INCOME AND RETAIL SALES they intend to buy to the total number of families in the survey. Source: United States Department of Commerce, Bureau of the Census. S e a so n ally adjusted a n n u a l ra te B illions of d o llars C h art 1 1 1 CONSUMER INTENTIONS TO BUY NEW AUTOMOBILES AND HOUSEHOLD DURABLES WITHIN SIX MONTHS Billions of do llars The prospect for automobile sales remains the foremost uncertainty in the outlook for consumer spending. While dealer sales of new cars averaged 8.3 million units in June and July, up sharply from the low May level of 7.3 million, it is not clear how much of this improvement has resulted from the intensive efforts of dealers to reduce their large stocks of 1966 models. Nonetheless, the automobile indus try itself is expecting some further gains in sales during the remainder of this year. The most recent survey of consumer buying intentions, taken in mid-July, indicates that the pro portion of families planning to purchase a new car within six months was roughly the same as last year’s reading (see Chart III). The proportion of families intending to buy one or more of the seven household durables included in the survey was substantially higher than a year ago, indicating that the consumer durables sector could make a further sizable contribution to expanding demand in the months ahead. E M P L O Y M E N T , W A G E S , A N D PR IC E S Note: Disposable personal income data are quarterly; retail sales data are monthly. Source: United States Department of Commerce, Bureau of the Census. The overall unemployment rate in August remained at the July level of 3.9 per cent of the civilian labor force, with 202 MONTHLY REVIEW, SEPTEMBER 1966 a slight increase in the rate of unemployment among adult women, a further decline among teen-agers, and no change for married men. The August figures reflect a gain in total employment roughly equal to the moderate advance in the civilian labor force. Even with the August increase, however, the growth of the civilian labor force this year has been sluggish. In the first eight months of 1966, the labor force has expanded by only three fourths the rate in the comparable period of 1965. It had been ex pected that labor force growth this year would be quite substantial, reflecting both demographic factors and the usual tendency for high-level economic activity to induce many persons into the labor force who otherwise would not enter the job market. Nevertheless, this expected strength in the civilian labor force did not develop due to such factors as the buildup in the armed forces, a larger than usual number of students remaining in school, in clement weather conditions that reduced employment in agriculture, and strikes in the construction and airline in dustries. The relatively slow growth of the labor force has been one of the factors tending to maintain the heavy pres sures on the available labor supply. A recent Labor Department report indicates that annual wage increases (excluding fringe benefits) in agreements involving 1,000 or more employees concluded in the first half of 1966 will average 3.7 per cent over the life of the contracts. Comparable negotiated wage increases averaged 3.3 per cent in 1965, 3.0 per cent in 1964, and 2.5 per cent in 1963. Moreover, the higher gains cited for the first half of this year exclude settlements in the construc tion industry, where increases have been especially large— averaging about 6 per cent a year during the first half of 1966. The prospect for still higher wage demands and settle ments in coming months may have been influenced by the well-publicized settlement in the airline industry which in volves, in addition to a large pay increase, a provision for cost-of-living adjustments. Furthermore, many important wage contracts are coming up for negotiation over the next twelve months. The price picture remains highly disturbing. The con sumer price index rose once again in July, although the advance in the food component was less than seasonal. Prices also mounted further at the wholesale level. The prices of farm products, which had leveled off in the early summer, jumped 3.4 percentage points in July for the largest monthly increase since March 1960. Part of the advance may be reversed as some commodities— such as eggs and livestock—resume their normal flow to market after being held up somewhat during the hot weather ex perienced in June and July in some regions of the nation. A large part of the price rise is likely to be sustained, how ever, as the spring drought and the prolonged heat wave have cut yield prospects for many types of grain crops and pasture feeds, especially in the south central and Atlantic seaboard states. Industrial wholesale prices also moved upward in July at a seasonally adjusted annual rate of 2.3 per cent, somewhat below the average monthly advance for the first half of the year. Against the background of rising demand and the possibility of large increases in future wage settlements, price pressures are likely to re main a problem in the months ahead. K E E PIN G O U R M O N E Y H E A L T H Y AND M O NEY: M ASTER OR SERVANT? The Federal Reserve Bank of New York has re vised two booklets which will be available free of charge at the end of September. Keeping Our Money Healthy, a 16-page booklet, is an illustrated primer on how the Federal Reserve System works to promote price stability, high em ployment, and economic growth in our economy. It discusses in a simplified fashion recession, inflation, the value of money, and the stabilizing influence of the Federal Reserve System. Money: Master or Servant?, a 48-page booklet, explains the role of money and banking in our econ omy. It includes a description of our monetary system, tells how money is created, and relates how the Federal Reserve System influences the cost, supply, and availability of credit as it seeks to en courage sustainable economic growth at high levels of employment with a reasonably stable price level. Requests for copies should be addressed to the Publications Section, Federal Reserve Bank of New York, New York, N. Y. 10045. FEDERAL RESERVE BANK OF NEW YORK 203 The M oney and Bond M ark ets in A ugust A sharp and persistent rise in interest rates amid an atmosphere of considerable uncertainty was the dominant feature of the money and securities markets through most of August. Technical rallies appeared on occasion, but they tended to fade rather quickly under the weight of a steady stream of economic and financial news that under scored both the continued heavy demand for credit and the limited availability of funds. As the month progressed, the view became widespread that monetary policy might tighten further, possibly increasing pressures on the market in September when commercial banks would be facing substantial seasonal loan demands and heavy ma turities of certificates of deposit. However, the atmosphere in the securities markets improved somewhat at the close of the month in response to renewed talk of a possible tax increase. On September 1, after the close of the period covered in this article, the Federal Reserve System issued a policy statement which is reprinted on page 211. Among the specific factors affecting the securities markets in August was the increase in the prime lending rate of commercial banks, from 53 per cent to 6 per A cent, that was announced on August 16 and 17. The boost was the fourth in less than nine months and raised the banks’ minimum lending rate to the highest level in over thirty years. Then, on August 17, the Board of Governors of the Federal Reserve System announced a further increase from 5 per cent to the statutory ceiling of 6 per cent in reserve requirements against certain time de posits of member banks. The new 6 per cent reserve re quirement will apply to each member bank’s time deposits —other than passbook savings accounts— in excess of $5 million. (Passbook savings deposits and the first $5 mil lion of other time deposit accounts will continue to be sub ject to a 4 per cent reserve requirement.) The increase, which follows a midyear rise from 4 per cent to 5 per cent in such requirements, will go into effect at reserve city banks in the reserve computation period beginning Sep tember 8, and will first apply to other member banks dur ing the reserve computation period beginning September 15. In announcing this increase in reserve requirements, the Board of Governors explained: “Like [the] earlier measure, [this] action is designed to exert a tempering in fluence on bank issuance of time certificates of deposit, and to apply some additional restraint upon the expansion of bank credit to businesses and other borrowers. Mone tary actions already taken have resulted in some modera tion of the rate of bank credit growth thus far this year. However, in view of increasing pressures on prices stem ming from recent developments in the economy, [this lat est] action is being taken to reinforce the anti-inflationary effects of overall monetary restraint.” Contributing to the upward pressure on interest rates during the month were the steady addition of prospective issues to an already sizable calendar of future corporate bond offerings, heavy commercial bank selling of taxexempt securities, an increase in the supply of Treasury bills with the sale of $3 billion of March and April tax anticipation bills, and expectations that the Federal Na tional Mortgage Association (FN M A )) would sell a large issue of participation certificates in September. Further more, dealer financing costs were persistently high during the month, making dealers hesitant to add securities to their inventories. Under the various pressures, yields on Treasury notes and bonds rose by as much as 77 basis points in August to their highest levels since the 1920’s. Yields on cor porate bonds reached thirty-year highs, and even at these levels investors proved to be only cautious buyers. In the tax-exempt bond market, yields also rose sharply over the month in a generally weak atmosphere. Treasury bill rates climbed to record levels, with average issuing rates on three- and six-month bills set at 5.09 per cent and 5.57 per cent, respectively, in the auction of August 29. The money market generally remained quite firm in Au gust. Federal funds traded mainly in a 5Vi to 5% per cent range, with the effective rate first reaching a record 5% per cent level on August 5. Commercial paper dealers raised their rates on two occasions during the month, bringing their offering rate on prime four- to six-month paper to 5% per cent. Rates on bankers’ acceptances also rose dur ing the period, reaching 5% per cent (bid) for 31- to 90-day unendorsed acceptances. Rates posted by the 204 MONTHLY REVIEW, SEPTEMBER 1966 Table I Table II FACTORS T EN D IN G TO INCREASE OR D ECREASE MEM BER BANK RESERVES, A U G U ST 1966 RESERVE POSITIONS OF MAJOR RESERVE CITY BANK S A U G U ST 1966 In millions of dollars; ( 4 ) denotes increase, (—) decrease in excess reserves In m illions of dollars Daily averages—week ended Factors affecting basic reserve positions Changes in daily averages— week ended Aug. 3 Aug. 10 Aug. 24 Aug. 17 Aug. 31 Federal Reserve f lo a t.......... Treasury operations-* . . . . . . ) Gold and foreign ac co u n t.. Currency outside banks*. . . Other Federal Reserve accounts ( n e t ) $ .................... Total "m arket” fa c to rs.. Direct Federal Reserve credit transactions Open market instrum ents Outright holdings: Government securities . . . Bankers' acceptances . . . Repurchase agreements: Government securities . . . Bankers’ acceptances . . . Member bank borrow ings___ Other loans, discounts, and advances .................................... August 10 August 17 August 24 40 4 . 221 + 91 4 236 — 219 — 613 — 336 — 29 — 249 — 83 — 234 — 115 4- 203 4-181 — 405 4 - 338 4 -i 200 4- 50 4- 17 4 - 29 + 13 — 15 4 - 144 628 766 18 4 . 94 — — — — 4- 199 —1,087 —1,000 4- 19S — 142 — 51 4 - 82 — 99 + 8 — 108 4 23 — 573 — 13 4-429 4 - 286 — 847 j Reserve excess or deficiency ( —) t ...................... Less borrowings from Reserve Banks ......................... Less net interbank Federal funds purchases or sales(—).. Gross purchases ................ Gross sales .......................... Equals net basic reserve surplus or deficit( —) ............ N et loans to Government securities dealers ..................... 4 _ 8 35 120 39 482 1,245 763 339 1,114 775 531 1,228 697 -4 6 4 — 452 — 535 5 178 -2 5 4 230 185 171 70 281 187 18 46 21 — 94 + 7 + 414 — 15 — — — 422 — 2 + 1 + 158 — 98 4- 194 — + 4 — 158 —■ — 52 — 194 — — 11 — 2 + 56 + 4 — 3 4 — — 66 4- 784 + 2 4- 369 4 724 — 16 _ — — 28 + 1 — 4- 11 — 4- 653 4- 145 — 638 — 201 4- 759 | +718 Excess reserves* ............. .......... 4 - 80 4 - 132 — 209 4- 85 — 88 1 ~ Reserve excess or deficiency ( —) f ....................... Less borrowings from Reserve Banks ......................... Less net interbank Federal funds purchases or sales(—).. Gross purchases ................ Gross sales ........................... Equals net basic reserve surplus or deficit ( —) ............ N et loans to Government securities dealers ..................... 32 — 11 - 132 920 913 931 1,045 242 1,084 842 1 32 28 16 20 19 223 139 193 100 61 143 681 1,556 875 796 1,681 885 738 1,651 913 724 1,670 946 570 1,686 1,117 702 1,649 947 -9 0 4 -9 0 2 — 903 105 4 58 — 808 - 6 1 1 - 7 - 826 214 75 N ote: Because of rounding, figures do not necessarily add to totals. * Estimated reserve figures have not been adjusted for so-called “ as o f” debits and credits. These items are taken into account in final data, t Reserves held after all adjustments applicable to the reporting period less required reserves and carry-over reserve deficiencies. Daily average levels Table III A V ERAGE ISSU IN G RATES* AT R E G U LA R T R EA SU R Y BILL AUCTIONS Member bank: Total reserves, including vault c a s h * ................................ 22,987 Required reserves* .................. 22,638 349 Excess reserves* .......... ........... B o rro w in g s........ ....................... 778 — 429 Free reserves* .............. .. Nonborrowed reserves* .......... 22,209 1 Thirty-eight banks outside N ew York City — 718 Total .................................. 22,898 22,417 481 782 — 301 22,116 22,598 22,326 272 730 — 458 21,868 22,447 22,090 357 719 — 362 21,728 22,578 22,309 269 691 — 422 21,887 In per cent 22,7025 22,356§ 346§ 740§ — 394§ 21,9628 Weekly auction dates— August 1966 Maturities August 1 August August 8 | 1 5 Three-month 4.834 4.826 Six-month .... Changes in Wednesday levels 4.969 5.050 System Account holdings of Government securities maturing in: August 22 August 29 5.048 5.020 5.087 5.315 5.410 5.566 Monthly auction dates— June-August 1966 Less than one y e a r .................. More th a n one y e a r ................ 4 662 Total .................................. 4 - 662 — 197 — 197 — 732 — 83 4 -3 8 — 815 4 38 4-847 4 - 618 — 83 Note: Because of rounding, figures do not necessarily add to totals. * These figures are estimated. t Includes changes in Treasury currency and cash. t Includes assets denominated in foreign currencies. § Average for five weeks ended August 31. August 31* Eight banks in N ew York City “ Market" factors Member bank required reserves* .......................... . Operating transactions August 3 Net changes Factors Average of five weeks ended August 31* 4 - 847 June 23 4 - 535 One-year July 26 August 25 4.697 4.964 5.844 * 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 New York City banks on call loans to Govern ment securities dealers were in a 6V4 to 6 % per cent range until late in the month, when rates as low as 5 V2 per cent were quoted. Leading commercial banks continued to pay the ceiling rate of 5 V2 per cent for negotiable time certifi cates of deposit maturing in thirty days or more. 205 refunding. Approximately $10.1 billion of the $14.9 bil lion outstanding August and November issues eligible for exchange was converted into the new offerings. Subscrip tions totaled approximately $5.9 billion for the new 5lA per cent certificates of 1967 and almost $4.3 billion for the new 5V4 per cent notes of 1971. Public holders of the elig ible maturing securities exchanged about $2.5 billion— or 78.5 per cent— of their $3.2 billion holdings of August 15 TH E G O V E R N M E N T SE C U R ITIES M A R K E T maturities, and $1.6 billion— or 33.5 per cent— of their Prices of Treasury notes and bonds declined sharply $4.9 billion holdings of November 15 maturities. The through most of August but recovered somewhat in the clos amount of August maturities exchanged was approxi ing days of the month. As the month opened, the Treasury’s mately in line with market expectations, while the amount August refunding operation, then in progress, held the mar of November maturities refunded somewhat exceeded ket spotlight.1 Immediately following the Treasury’s July 27 earlier market estimates, leaving only routine refinancing refunding announcement, prices of many outstanding cou on the Treasury calendar for November. pon issues moved down by as much as half a point, The refunding results had little effect upon price quota partly in adjustment to the additional supplies of five-year tions in the coupon sector, where attention was increasingly maturities which would arise out of the refunding. In addi focusing upon other considerations. The tone of the market tion, the market anticipated a considerable amount of deteriorated considerably in the wake of an August 9 fea switching out of outstanding coupon issues into the new ture article in the financial press which predicted that heavy refunding offerings—particularly into the new 5V4 per cent loan demands might soon trigger another increase (subse notes of 1971. Some such switching did indeed occur, par quently confirmed) in the prime lending rate of commercial ticularly out of the 5 per cent notes of 1970 into the refund banks. The coupon sector was also adversely affected ing issues. On balance, however, investor interest in the by the heavy atmosphere evident elsewhere in the capital new 5Va per cent certificates and notes—trading in the markets where new corporate and agency issues floated at secondary market on a “when issued” basis—was rather record yields were encountering investor apathy. Dealer limited. Against this background, prices of outstanding cou offerings continued to expand, some commercial bank pon issues and the new refunding issues fluctuated nar sales took place, and prices of the new refunding issues rowly in dull trading during the August 1-3 subscription and of outstanding securities steadily gave ground. The period. price decline gathered momentum around midmonth After the refunding subscription books closed on August and, for some time afterward, daily price losses of up to 3, prices of outstanding intermediate- and long-term issues V2 point on individual issues became commonplace. The drifted lower in light trading as the market awaited the August 16-17 rise in the prime lending rate of commercial results of the refinancing operation. Dealers became pro banks further depressed the securities market and reinforced gressively more anxious to make sales— even at lower apprehension that monetary policy would become more re prices— as they reacted to reports that the calendar of strictive. In this atmosphere, the increase in reserve require scheduled corporate and Government agency financing ments against certain time deposits, announced by the Board was growing rapidly, and to predictions that credit de of Governors on August 17, triggered another sharp down mands would be exceptionally large in the autumn. At ward adjustment in prices of coupon issues. (The rightthe same time, investor offerings expanded when some hand panel of the chart on page 208 illustrates the rise in switching from outstanding long-term Treasury issues yields which accompanied this decline in prices.) As the month progressed, market participants also be into higher yielding corporate bonds developed. During this period, market participants also assessed the poten came increasingly concerned over the ability of commercial tial impact of the increase in steel prices upon the gen banks to replace the heavy volume of certificates of deposit eral level of prices and interest rates. soon to mature, since rates on several competing money On August 5, the Treasury announced the results of the market instruments had risen above the 5 V2 per cent ceiling rate on time certificates. The feeling was widespread among market participants that, should commercial banks en counter difficulty in rolling over their maturing certificates, bank sales of Government securities and/or tax-exempt 1 For details of the offering, see this Review (August 1966), issues would accelerate. In addition, dealers became ap page 177. 206 MONTHLY REVIEW, SEPTEMBER 1966 SELECTED INTEREST RATES* Percent M O N E Y MARKET RATES June July June-August 1966 August BOND MARKET YIELDS June July Percent August Note: D ata are shown for business days only. M O N E Y MARKET RATES QUOTED: D aily range of rates posted by m ajor N ew York City banks on new call loans (in Federal funds) secured by United States Governm ent securities (a point indicates the absence of any range); offering rates for directly placed finance com pany paper; the effective rate on Federal funds (the rate most representative of the transactions executed); closing bid rates (quoted in terms of rate of discount) on newest outstanding three- and six-month Treasury bills. same issue im m ediately afte r it has been released from syndicate restrictions); d a ily o r more) and of Governm ent securities due in three to five years, computed on the basis of closing bid prices; Thursday averages of yields on twenty seasoned twenty-ye a r ta x-exem pt bonds (carrying M oody’s ratings o fA a a ,A a , A , and Baa). BOND MARKET YIELDS QUOTED: Yields on new A a a - and A a-rated public utility bonds are plotted around a line showing daily averag e yields on seasoned A aa -ra te d corporate bonds (arrows prehensive about the availability of funds to finance their positions. New York City bank rates on dealer loans were quoted as high as 6% per cent, and only a limited amount of funds was available from out-of-town sources. A some what improved market tone developed at the end of the month when participants responded favorably to renewed discussion of a possible anti-inflationary tax increase. Demand for coupon issues expanded and prices rebounded, erasing a portion of their earlier losses. A very cautious atmosphere was also evident in the Treasury bill market through most of August. The rapid general rise in interest rates— including the increase in the prime lending rate of commercial banks— compounded the uneasiness of bill market participants as they weighed the rate outlook in their own sector. In the opening days of point from underwriting syndicate reoffering yield on a given issue to m arket yield on the averages of yields on long-term Government securities (bonds due or callab le in ten years Sources: Federal Reserve Bank of N ew York, Board of Governors of the Federal Reserve System, Moody's Investors Service, and The W e e k ly Bond Buyer. August, investment demand favored the short-dated bills, which were in scarce supply in the market, and rates re ceded slightly in the under-three-month maturity area. At the same time, however, little investor interest was evident in longer bills, which continued to edge higher in rate. Market sentiment was dampened considerably when the magnitude of reinvestment demand for bills of various maturities from sellers of “rights” to the Treasury’s August refinancing of coupon issues fell short of earlier market expectations. From August 8 onward, the upward rate movement spread into the shorter bill maturity area as well (see the left-hand panel of the chart). Offerings of these issues in creased and demand for them tapered off. On August 11, the Treasury announced that it would auction $2 billion FEDERAL RESERVE BANK OF NEW YORK of March 1967 tax anticipation bills and $1 billion of April 1967 tax bills on August 18. In the wake of the announcement, which came at a time when market uncer tainty over the interest rate outlook was growing, rates on outstanding bills moved sharply higher, largely as a result of aggressive dealer offerings. At the regular weekly bill auction on August 15, where bidding was quite restrained, average issuing rates climbed to 5.048 per cent for the new three-month bill and 5.315 per cent for the sixmonth issue (see Table III). Another marked increase in bill rates took place in reaction to the rise in the prime rate announced by most commercial banks on August 16 and 17. At the August 18 auction of the tax antici pation bills, effective bidding was confined to commercial banks, which were permitted to make full payment through credits to Treasury Tax and Loan Accounts— a privilege estimated by the market to be worth about 30 to 35 basis points to the banks. Nevertheless, banks anticipated some difficulty in distributing the tax bills in the secondary market and therefore bid very cautiously. Average issu ing rates were set at 5.338 per cent for the March bills and 5.433 per cent for the April bills, historic highs for such securities. For a brief period following the tax bill auction, the bill market rallied when demand expanded somewhat. Rates for outstanding bills edged lower with the sharpest declines recorded by short bill maturities. Subsequently, however, the bill sector weakened again. At the regular monthly auc tion of one-year bills on August 25, an average issuing rate of 5.844 per cent was set, almost 90 basis points higher than the average rate at the preceding monthly auction. (When measured on a bond yield equivalent basis, the yield on this issue was 6.20 per cent.) The bill market rallied late in the month, when demand expanded somewhat and rates turned downward. Nevertheless, at the end of the month, the newest outstanding three- and six-month Treasury bills were bid at rates of 5.06 per cent and 5.58 per cent, respec tively, 29 and 62 basis points above the rates quoted on comparable issues a month earlier. In the market for United States Government agency obli gations, participants displayed considerable concern over the general outlook for interest rates and the expanding calendar of scheduled agency flotations. Consequently, prices in this market fell back steadily through most of the month. Several new agency issues, which were floated at or close to record high yields, were accorded mixed investor receptions. Early in the period, the FNMA publicly offered $300 million of new two-year debentures priced to yield 5.91 per cent, and sold an additional $50 million of the issue to Treasury trust accounts. The publicly offered de bentures encountered investor resistance and their yield 207 rose in subsequent secondary market trading. Around mid month, a public offering by the Federal Home Loan Banks of $500 million of one-year bonds, priced to yield a new record high for agency financing of approximately 6 per cent, also encountered investor apathy. Later in the month, the market was further restrained by discussion of the pos sibility that a sizable offering of participation certificates might be made in September. However, some improvement in the atmosphere of the agency market occurred at the end of August following press reports that no firm decision had yet been made with respect to this offering. O TH ER SE C U R IT IE S M A R K E T S In the markets for corporate and tax-exempt bonds, prices generally fell back sharply until late in August as participants became increasingly concerned over the mounting demands for credit converging upon their mar kets. A better atmosphere emerged in both sectors at the end of the month, however, when participants reacted to re newed discussion of a possible tax increase. Historically, a lull in new issue activity has generally developed in the capital markets during August, but such was not the case this year. New publicly offered corporate bonds totaled $1.2 billion in August, the largest volume ever recorded in a single month. Early in the month, market attention fo cused upon the American Telephone and Telegraph Com pany $250 million flotation of Aaa-rated 55 per cent A debentures maturing in 1995 which were sold at the highest net interest cost to the company in over forty years. These securities, which carried five-year call protection, were ag gressively bid for by underwriters. When first reoffered to yield 5.58 per cent, the debentures attracted good interest from small investors. Subsequently, however, distribution of the issue slowed considerably, syndicate price restric tions were removed, and the debentures initially jumped 6 basis points in yield when they began to trade freely. By the end of the month, the telephone issue was trading to yield as much as 5.82 per cent. Other new corporate issues were generally accorded mixed receptions during the month. Only issues that carried extended protection against early call, had delayed delivery provisions, and were reoffered at considerably reduced prices drew any investor interest. Prices of recent corporate offerings and seasoned issues also fell sharply during the month (see the comparable rise in yields illustrated in the right-hand panel of the chart), although a steadier tone emerged at the end of the period. In the tax-exempt sector, prices of new offerings and sea soned issues dropped sharply through most of the month in an uncertain atmosphere and yields rose to their highest levels in more than thirty years. Commercial banks con 208 MONTHLY REVIEW, SEPTEMBER 1966 tinued to reduce their holdings of tax-exempt securities on a fairly large scale, while dealers were able to make sales from their inventories only after progressive price conces sions. New tax-exempt bond flotations totaled about $735 million in August, as against $630 million (revised) the month before and about $720 million in August 1965. Several new tax-exempt issues which had been scheduled for sale during the month failed to reach the market either as a result of postponements or because prevailing market yields exceeded certain local statutory interest rate limita tions. The largest new tax-exempt bond offering of the month consisted of $100 million of Aa-rated state bonds. The bonds were reoffered just after midmonth to yield from 4 per cent in 1967 to 4.20 per cent in 1987, and were fairly well received due in part to their relatively attractive yield. Over the month as a whole, the average yield on Moody’s seasoned Aaa-rated corporate bonds rose by 21 basis points to 5.44 per cent, while The Weekly Bond Buyer's series for twenty seasoned tax-exempt issues (carrying ratings rang ing from Aaa to Baa) climbed by 28 basis points to 4.24 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 move ments fully, particularly in the case of new and recent issues. the five-week August period, as against $739 million dur ing the four weeks ended July 27. The distribution of reserve pressures shifted somewhat in August from the pattern that had prevailed during most of July. The reserve positions of banks outside the major money centers came under increased pressure, and these banks turned more frequently to the Federal Reserve “dis count window” to fill their residual reserve needs. At the same time, the reserve positions of money market banks—particularly those located in New York City— were under somewhat reduced pressure (see Table II). The improve ment in the reserve positions of banks in the central money market largely reflected a decline in their lending to Govern ment securities dealers who, faced by call loan rates of 6V4 per cent to 65 per cent at New York banks, kept /s their inventories low and increasingly sought out less ex pensive sources of funds to fill their limited financing needs. Rates on a variety of short-term money market instru ments continued to move upward during the month. By the end of August, offering rates on commercial paper placed by dealers were Va of a per cent higher than a month earlier, and rates on bankers’ acceptances were generally Vs of a per cent higher. The major New York City banks con tinued to pay the 5 V2 per cent ceiling rate on all maturities of new negotiable time certificates of deposit. Rates on prime certificates trading in the secondary market edged THE M O NEY M ARKET AND BANK RESERVES steadily higher, reaching a 5% to 6 per cent range on The money market was quite firm during most of Au three-month maturities and a 5.8 to 6Va per cent range gust, although a slightly easier tone emerged toward the on six-month maturities by the end of the month. Over end of the month. Nationwide net borrowed reserves aver $3.7 billion of outstanding negotiable certificates of de aged $394 million during the five weeks ended August 31, posit matured at large commercial banks in August, and little changed from the revised level of the month before an additional $6.7 billion is scheduled to come due over (see Table I). Reflecting the persisting pressures on com the September-October period. With interest rates on most mercial bank reserve positions, Federal funds were competing money market instruments above the 5 V2 per strongly bid through most of the month. The effective rate cent ceiling rate applicable to new time certificates, com on such funds generally ranged from 5Vi per cent to a mercial banks were faced with the prospect of mounting record 5Vs per cent and, for the first time, some trad difficulties in replacing maturing certificates. In August, ing occurred at 6 per cent— l Vi per cent above the Fed negotiable time certificates outstanding at weekly report eral Reserve discount rate. Member bank borrowings from ing member banks in New York City declined by $263 the Federal Reserve Banks averaged $740 million during million. FEDERAL RESERVE BANK OF NEW YORK Federal R eserve System Policy Statem ent On September 1, 1966, the Federal Reserve System issued the following statement: It is the view of the Federal Reserve System that orderly bank credit expansion is appropriate in to day’s economy. However, that expansion should be moderate enough to help insure that spending— and particularly that financed by bank credit— does not exceed the bounds that can be accommodated by the Nation’s growing physical resources. An excessive expansion of bank credits would aggravate inflation ary pressures that are already visible. While the growth of total bank credit and total bank lending has moderated somewhat as compared with last year, total bank loans plus investments have grown at an annual rate of over 8 per cent during the first eight months of this year, and total bank loans at a rate of over 12 per cent. Meanwhile, bank lending to business has increased at an annual rate of about 20 per cent. It is recognized that business demands for bank credit have been particularly intense. While such credit requests often appear justifiable when looked at individually, the aggregate total of credit-financed business spending has tended towards unsustainable levels and has added appreciably to current inflation ary pressures. Furthermore, such exceedingly rapid business loan expansion is being financed in part by liquidation of other banking assets and by curtail ment of other lending in ways that could contribute to disorderly conditions in other credit markets. The System believes that the national economic interest would be better served by a slower rate of expansion of bank loans to business within the con text of moderate overall money and credit growth. Further substantial adjustments through bank liquida tion of municipal securities or other investments would add to pressures on financial markets. Hence, the System believes that a greater share of member bank adjustments should take the form of modera tion in the rate of expansion of loans, and particu larly business loans. Accordingly, this objective will be kept in mind by the Federal Reserve Banks in their extensions of credit to member banks through the discount win dow. Member banks will be expected to cooperate in the System’s efforts to hold down the rate of business loan expansion— apart from normal season al needs— and to use the discount facilities of the Reserve Banks in a manner consistent with these efforts. It is recognized that banks adjusting their positions through loan curtailment may at times need a longer period of discount accommodation than would be required for the disposition of securities. This program is in conformity with the provision in section 201.0, paragraph (e), of the Board’s Reg ulation A governing lending to member banks: “In considering a request for credit accommodation, each Federal Reserve Bank gives due regard to the pur pose of the credit and to its probable effects upon the maintenance of sound credit conditions, both as to the individual institution and the economy gen erally___ ” Federal Reserve credit assistance to member banks to meet appropriate seasonal or emergency needs, including those resulting from shrinkages of deposits or of other sources of funds, will continue to be available as in the past. A slower rate of business loan expansion is in the interest of the entire banking system and of the economy as a whole. All banks should be aware of this consideration, whether or not they need to bor row from the Federal Reserve. Management of bank resources in accordance with the principles out lined above can make a constructive contribution to sustained economic prosperity, and the Federal Re serve System is confident that the banks will give their wholehearted support to this effort. 209
