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It's official: interest rates are up.

Interest rates are up sharply for bonds in the first half of the year. Yields on the 30 year Treasury bonds began the year below 60 percent and started its continuous ascent in mid-February to above seven percent by the beginning of May. However, the seven percent mark has not yet proven that it can hold its ground. Brief rallies have produced about a 12 point spread over and below the psychologically important seven percent a benchmark. On June 1st bond prices again tumbled sending the yields above seven percent and by June loth yields on the long term bonds hit 7.12 percent, the highest level in more than a year.

The next Federal Open Market Committee meetings are set for July 3rd and August 20th. While many analysts had been predicting lower interest rates earlier in the year, most analysts re now quarter point increase in the August meeting. There are predictions of four percent growth in the second quarter of the year and that could be enough to push the Feds over the edge. However, the sharp increases in the bond yields may be enough to thwart the need for the Feds to raise the discount rate. Bond traders have raised the yields on bonds (which move in the opposite direction of bond prices) over 100 bills points or one percentage point thus far this year.

Signs of strong economic growth

The housing market rebounded in April and May, with new home sales especially out performing expectations. New homes in particular, will put ore people to work this summer. Everyone from construction workers to appliance makers should be impacted. Also, keep in mind that the housing sector was strong despite the higher interest rates banks are now offering. Some buyers have entered the market precisely because of the rising cost of borrowing and have now gotten off the fence after being disappointed earlier in the year when the Feds passed up cutting interest rates.

Retail sales have rebounded a bit and they are well ahead of last years figures. Consumer Stocks are a favorite with investors who are reacting to the news of increased consumer confidence and spending. Makers of large ticket items and durable goods are particularly doing well. Shelf inventories are down and new orders will put many laid off workers back on the assembly line adding pressure to an already tight job might.

Inflation on the Horizon?

Fear of inflation now appears to be driving the financial markets. Recent strong housing data, relatively low unemployment, and an increase in oil and farm prices are worrying investors. I'm not sure the bond market can stand much more good news about the state of the economy.

Ghoulish bond traders are concerned that inflation will eat away at their profits. Low unemployment is a harbinger of higher prices due to higher wages, caused by a shortage of available workers. Has anybody told these guys it's an election year and a rosy economy will be embraced by the incumbent administrations? The unemployment figures have been below six percent for over a year and a half. Some economists believe that a six percent unemployment is the lowest attainable benchmark before the demand for workers will drive up wages inflation. However, today we are competing in a global economy with increased access to overseas workers, which exerts downward pressure on prices.

Recent signs of strong growth in the economy has raised fears of future inflation, even though inflation has thus far remained rather tame. However, keep a close eye on gold prices if there are any real serious signs of inflation. Gold prices have thus far remained below $400 an ounce. Run for the hills if you see gold prices go over $400 an ounce since some bond investors will switch to the gold market as a protection against strong inflation that can erode the value of their investments.

Volatility on Wall Street

This year has quickly become another record setting year on Wall Street. The Dow Jones began the year with a continuation of last years string of new records. The Dow rose from 5,100 in mid-January to 5,600 on February 12th.

The market then spent the next two and a half months fluctuating between 5,400 and 5,700, largely in the wake of the tides of the bond market. However, the Dow finally broke through the 5,700 barrier on May 20th and then set its 21st new record of the year a few days later when it reached 5,778. All these new records for the Dow are proof of the market's volatility.

Just how volatile is the stock market you ask? In the period between midday May 8th, after starting the trading session down some 75 points, and May 20th, when the Dow reached 5,700, the Dow performed an incredible about face on the heels of low inflation data released by the Commerce Department. The New York Times reported on May 21st, that, "In just eight and a half sessions, the Dow industrials have risen more than 400 points or 7.6 percent. Since the start of the year, the Dow is now up somewhere around 12 percent over the past six months.

Need more proof of the market's volatility? Further evidence can be seen by the number of times the NYSE computerized trading curb has been set off due to large swings in the market. From January 1st through the end of May of this year, the computerized trading curb has been triggered 56 times due to fluctuations during trading sessions. By comparison computerized was halted only 28 times in all of 1995 which was itself a very volatile year. But the market now seems to take 100 point swings in stride.

Other News

Item: In April, The White House and Congress finally reached agreement on the 1996 spending bill. The debate was settled without much fanfare, considering the way the budget agreement drove the financial markets towards the end of last year. After seven months of stop-gap budgets, investors were relieved that the chances of the government defaulting on its debts have subsided.

Item: On May 22nd, the House approved an increase in the minimum wage from $4.25 an hour up to $5.15. It is yet to be determined what impact the increase will have on wages and prices. The job market remains strong with unemployment at around 5.4 percent across the country.

Item: Treasury has proposed issuing government bonds that will be tied to inflation. Although the proposal seems to be in the embryo stage, a bond that would guard the erosive effects of inflation would be well received by investors. Bond traders could finally have their cake and eat it too.

Conclusion

Through it all, the commercial mortgage market remained extremely active in recent months. Many property owners have decided to refinance now after refinance that the Feds will not readily drop rates again. Our office has experienced a flood of new applications this Spring. There is a growing competition between lenders for good loans, and many banks are inundated with now submissions. Expect interest rates to continue to rise if the economy shows no sign of slowing down this summer. Experience and quick results are crucial in this volatile market.
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Copyright 1996, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:Mid-Year Review and Forecast
Author:Stumpf, David X.
Publication:Real Estate Weekly
Date:Jun 26, 1996
Words:1216
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