An abstract for this article is not available.Financial markets

B. Gayle Ennis

English

Research Papers in Economics

FINANCIAL  FORECASTS:  1975 
The  views  and opinions  set forth  in this article  are those  of 
various  forecasters.  No  agreement  or  endorsement 
by  this Bank  or  by  the author  is implied. 
Conditions  in  financial  markets  were  extremely 
volatile  during  1974,  primarily  as  a  result  of  unfore- 
seen  developments  in  the  economy.  Last  year  was  a 
very  bad  year  for  forecasters,  but  who  would  have 
anticipated  double-digit  inflation,  the  worsening  en- 
ergy  problem,  and  the  sharp  fall  in  output  and  in- 
crease  in  unemployment  in  the  fourth  quarter.  Be- 
cause  many  of  these  factors  that  played  havoc  with 
the  1974  forecasts  must  still  be  dealt  with  in  1975, 
this  year’s  forecasters  are  justifiably  reticent  about 
the  soundness  of  their  predictions.  It  is  for  this 
reason  and  in  the  interest  of  dependability  that  the 
predictions  used  for  this  “consensus”  were  limited  to 
those  compiled  after  mid-January  of  this  year,  after 
some  of the  major  uncertainties  were  clarified.  Fore- 
casts  compiled  before  the  fourth  quarter  GNP  figures 
were  announced,  before  the  latest  deficit  estimates 
were  available,  or  before  the  President’s  economic 
package  was  unveiled  would  obviously  be premised  on 
the  wrong  set  of  economic  variables,  thus  rendering 
them  obsolete. 
Apart  from  the  other  problems,  the  energy  situ- 
ation  makes  any  forecast,  financial  or  otherwise,  un- 
certain  at  best.  Fiscal  and  monetary  policies  will  be 
geared  to  adjust  to  developments  as the  year  unfolds. 
The  key  for  policymakers  in  1975  should  be  flexi- 
bility. 
FUNDS  RAISED  IN  1975 
The  total  volume  of  funds  raised,  without  regard 
to  maturity,  is  expected  to  register  roughly  $167 
billion  in  1975,  somewhat  lower  than  the  $172  billion 
raised  in  1974  (Table  I).  The  decline  should  affect 
all  maturity  lengths  to  some  degree,  but  the  severest 
impact  of  the  reduction  is  expected  to  be  felt  in  the 
short-term  sector  of the  market,  where  volume  should 
drop  from  $93  billion  in  1974  to  an  anticipated  $88 
billion  in  1975.  The  decline  in  the  long-term  market 
should  be  negligible,  with  volume  remaining  close  to 
last  year’s  figure  at  $79  billion.  Some  downward 
adjustment  in  short-term  rates  should  occur  during 
the  year;  long-term  rates  might  also  decline  slightly 
but  to  a  lesser  degree  than  in  the  short-term  sector. 
Four  categories  of  borrowers  that  must  be  examined 
in  any  discussion  of  the  funds  markets  are:  banks, 
business,  consumers,  and  government.  The  past  year 
saw  an  unprecedented  demand  for  bank  credit  as  the 
spread  between  the  prime  rate  and  the  commercial 
paper  rate  moved  out  of  traditional  alignment.  Total 
bank  loans  were  roughly  $34  billion  this  past  year, 
exceeding  the  figure  for  1973,  which  was  also  high 
by  historical  standards.  The  demand  for  bank  credit 
eased  during  the  fourth  quarter  of  1974, and  for  1975 
as  a  whole  bank  loans  should  total  a  more  moderate 
$13  billion.  In  conjunction  with  this,  the  prime  rate 
is  expected  to  continue  to  decline  to  a  level  more  in 
line  with  other  short-term  rates  during  1975. 
The  volume  of  business  loans  is  expected  to  vary 
dramatically  both  in  size  and  composition  during 
1975,  with  the  emphasis  shifting  from  the  short-term 
to  the  long-term  market.  In  1974 the  business  sector 
raised  approximately  $28  billion  in  long-term  funds; 
this  figure  is  forecast  to  increase  only  slightly  to 
Table  I 
CONSENSUS  FUNDS  FORECASTS* 
*These  numbers  represent  on  estimate  of  the  consensus  forecasts 
of  many  well-known  economists;  all  forecasts  were  compiled  after 
the  President’s  economic  package  was  revealed  in  mid-January. 
22  ECONOMIC  REVIEW,  MARCH/APRIL  1975 about  $31  billion  in  1975.  The  composition  of  this 
borrowing  should  shift,  however,  so  that  in  the 
coming  year  there  would  be a jump  in corporate  bond 
volume  up  to  $28  billion,  with  stock  volume  sliding 
down  to  roughly  $3  billion.  A  subsequent  dramatic 
shift  in  short-term  business  borrowing  is  expected  to 
accompany  the  realignment  in  the  long-term  market. 
Short-term  financing  in  the  business  sector,  which 
jumped  to  an  astounding  $50  billion  last  year,  should 
fall  off  to  only  $22  billion  in  1975.  The  forecast  for 
sharply  lower  bank  loan  volume  accounts  for  most 
of  this  contraction. 
Consumer  demand  for  funds  in  1975  is  expected 
to  be  very  light.  Net  borrowing  by  consumers  is 
forecast  to  amount  to  only  $38  billion,  off  from  $46 
billion  this  past  year.  The  decrease  is  wholly  attrib- 
utable  to  an  anticipated  $7  billion  decline  in  short- 
term  consumer  credit-installment  loans-as  automo- 
bile  and  consumer  durables  sales  remain  at  low  levels. 
The  volume  of  privately-held  mortgage  funds  should 
total  approximately  $35  billion  in  the  coming  year, 
Even  though  inflows  at  thrift  institutions  are  ex- 
pected  to  continue  throughout  the  year,  mortgage 
demand  is likely  to be weak.  Mortgage  money  should 
be  more  readily  available  in  1975  than  in  the  past 
year,  but  the  nominal  cost  is expected  to  remain  high 
by  historical  standards. 
The  most  dramatic  development  in  the  funds  mar- 
kets  this  year  should  be  the  anticipated  record level 
of  government  borrowing.  Forecast  at  $76  billion, 
the  volume  of  funds  raised  by  the  Federal  Govern- 
ment,  state  and  local  governments,  and  the  Agencies 
would  account  for  45  percent  of  the  total  funds 
raised  in  1975.  This  dramatic  upsurge  in government 
borrowing  is  attributable  to  the  anticipated  sharp 
jump  in  Federal  Government  borrowing  from  $10 
billion  in  1974  to  an  expected  $54  billion  in  1975. 
These  figures  are  subject  to  a  wide  degree  of  fluctu- 
ation,  and  the  forecasts  for  Federal  borrowing  range 
from  a  low  of  $41  billion  to  a  high  of  $65  billion, 
Whatever  the  figure  might  turn  out  to  be, the  Federal 
Government  will  definitely  need  a  large  supply  of 
funds  to  finance  the  proposed  “economic”  and  “en- 
ergy”  packages. 
In  other  sectors  of  the  government  market,  the 
volume  of funds  raised  in  1975 is expected  to  decline. 
The  Agencies  who  were  frequent  borrowers  in  1974, 
should  need  only  $9  billion  in  1975,  less  than  half 
last  year’s  total.  State  and  local  governments  are 
forecast  to  borrow  $13  billion  in  the  coming  year, 
slightly  below  their  1974  level  of  borrowing. 
Although  there  is currently  a  great  deal  of  serious 
debate  on  the  subject,  the  consensus  of  the  forecasts 
*These  numbers  represent  an  estimate  of  the  consensus  forecasts 
of  many  well-known  economists;  all  forecasts  were  compiled  after 
the  President’s  economic  package  was  revealed  in  mid-January. 
†  3-month  maturity. 
predicts  that  there  will  be  enough  funds  available  to 
satisfy  all  borrowers  in  1975  at  current  or  lower 
levels  of  interest  rates.  One  opinion  holds  that  the 
massive  Government  borrowing  necessary  to  support 
the  anticipated  1975  budget  deficit  will  overwhelm 
the  markets,  causing  a dearth  of funds  for  the  private 
sector.  This  opinion  is  premised  on  the  assumption 
that  in  1975  the  borrowing  needs  of  the  private 
sector  will  be  stronger  than  is  usually  characteristic 
of a recessionary  period.  There  are  two  main  reasons 
for  this  assumption  :  (1)  heavy  financing  of  oil  con- 
sumption  both  at  home  and  abroad,  and  (2)  large 
external  financing  needs  of  business  because  of  gen- 
erally  tight  liquidity  positions.  The  opposing  opinion 
speculates  that  although  business  borrowing  is  ex- 
pected  to  remain  firm  in  the  long-term  sector,  short- 
term  business  borrowing  will  abate.  This  fact,  com- 
bined  with  sharply  lower  anticipated  levels  of 
consumer  and  Agency  demand  for  funds,  should 
free-up  abundant  funds  for  other  potential  borrowers, 
thus  averting  any  credit  crunch.  The  consensus  of 
the  forecasts  seems  to agree  with  this  latter  argument. 
THE  INTEREST  RATE  OUTLOOK 
Interest  rates  are  undoubtedly  the  most  volatile 
part  of  any  financial  forecast.  The  past  year  was  a 
bitter  experience  for  most  rate  forecasters,  and  as  a 
result,  most  predictions  for  1975  mention  rates  only 
briefly,  if  at  all.  It  is  impossible  to  predict  the  be- 
havior  of  interest  rates  without  knowing  other  vari- 
ables  such  as  money  supply  growth.  A  small  change 
in the  rate  of growth  of  the  money  supply  can  perme- 
ate  rate  structures  and  alter  rate  relationships  and 
behavior  patterns.  For  this  reason,  there  is  neces- 
sarily  a  wide  margin  for  error  in  interest  rate  fore- 
casting.  The  consensus  view,  as  shown  in  Table  II, 
is  that  short-term  rates  will  continue  to  decline  from 
the  levels  prevailing  at  the  end  of  1974.  The  decline 
FEDERAL RESERVE  BANK  OF  RICHMOND  23 Federal  Reserve  Bank  of  Richmond 
P.  O.  Box  27622 
Richmond,  Virginia  23261 
Address  Correction  Requested 
will  be  moderated  and  may  be  reversed  if  intensified 
inflationary  fears  begin  to  pervade  financial  markets 
later  in  the  year  or  if  the  economic  recovery  is  unex- 
pectedly  strong.  But  such  factors  as  a  decreased 
demand  for  short-term  funds  combined  with  the  ex- 
pectation  of  a  less  stringent  monetary  policy  may 
exert  downward  pressure  on  short  rates.  Long-term 
rates  may  continue  to  exhibit  strong  inflationary 
premiums  throughout  1975  if  some  strong  evidence 
of  easing  pressure  on  prices  is  not  clearly  visible. 
These  rates  are  expected  to  move  slightly  lower, 
however,  as  a  minimal  decline  in  the  long-term  vol- 
ume  and  an  improved  economic  outlook  help  to  ease 
some  rate  pressures.  The  downward  movement  in 
long-term  rates  will  lag  short-term  rate  declines,  and 
the  movement  should  be  far  less  volatile.  Toward 
the  close  of  1975,  rates  may  move  up  in  both  long- 
and  short-term  markets  as  the  economic  recovery 
gets  under  way  and  especially  if money  supply  growth 
is  too  rapid  and  inflation  is  refueled.  A  closer  look 
at  the  anticipated  behavior  of  some  individual  rates 
may  produce  a  clearer  picture  of  1975  predictions. 
Short-term  rates  As  Table  II  indicates,  the  con- 
sensus  rate  on  three-month  Treasury  bills  is  ex- 
pected  to  decline  some  100  basis  points  by  the  close 
of  1975 to  a level  of  6.00  percent.  Anticipated  heavy 
Treasury  activity  in  the  short-term  market  combined 
with  a  reduced  demand  for  short-term  funds  account 
for  the  predicted  downward  pressure  on  bill  rates. 
In  the  market  for  3-month,  dealer-placed  commercial 
paper,  the  rate  declines  are  predicted  to  be  more 
dramatic.  By  the  close  of  1975 the  CP  rate  should  be 
at  6.75  percent,  dropping  lower  early  in  the  year  and 
then  moving  back  up  to  this  level.  This  rate  is  250 
basis  points  below  the  year-end  1974  figure  and  even 
more  sharply  below  the  1974  high.  Closely  related 
to  the  commercial  paper  rate  is  the  rate  charged 
prime  bank  borrowers-the  prime  rate.  After  rising 
to  a  whopping  12 percent  in  1974,  the  prime  rate  is 
forecast  to  end  1975 at  8.00  percent  ; a  rate  below  this 
level  is  forecast  for  the  first  half  of  the  year.  Such 
an  adjustment  would  bring  the  prime  rate  into  more 
traditional  alignment  with  the  commercial  paper  rate, 
although  the  spread  would  continue  to  be  slightly 
wider  than  normal. 
Long-term  rates  The  consensus  forecast  for  1975 
shows  long-term  rates  declining  only  slightly  from 
rates  at  the  end  of  1974,  with  no  dramatic  movement 
expected.  The  rate  on  new  issue  Aa  utility  bonds 
should  fall  to  9.40  percent,  10  basis  points  below 
1974,  while  the  rate  on  Aaa  corporate  bonds  is  ex- 
pected  to  close  1975  at  8.80  percent,  again  only  10 
basis  points  below  the  level  at  the  end  of  1974.  The 
pattern  of  rate  behavior  in  the  long-term  sector  could 
shift  dramatically  if  forecasters  have  underestimated 
corporate  financing  needs  for  1975  or  if due  to factors 
outside  the  corporate  market,  inflationary  expecta- 
tions  become  re-entrenched  in  the  second  half. 
MONETARY  POLICY 
The  behavior  of  the  monetary  aggregates  plays  a 
critical  role  in  shaping  conditions  in  financial  mar- 
kets.  The  conflicting  forces  of  slowed  economic 
growth,  inflation,  reduced  productivity,  and  high  un- 
employment  will  be  pulling  against  each  other  in  the 
coming  year,  each  exerting  an  influence  on  the  course 
of  monetary  policy.  The  consensus  of  the  forecasts 
shows  that  a policy  of  relative  ease  is anticipated  with 
moderate  growth  in  the  aggregates.  A  money  supply 
growth  rate  in  the  range  of  6.5  to  8  percent  is  the 
consensus  forecast,  with  the  caution  by  forecasters 
that  the  monetary  authorities  must  move  toward  a 
policy  that  allows  the  aggregates  to  expand  at  a  pace 
consistent  with  balanced  economic  growth  and  long.- 
term  price  stability,  carefully  avoiding  the  rekindling 
of  inflationary  fires. 
B.  Gayle  Ennis 
24  ECONOMIC  REVIEW,  MARCH/APRIL  1975 

Financial forecasts : 1975

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Financial forecasts : 1975

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Research Papers in Economics