2
pressure the Fed in early 1994 began to raise key short-term interest rates again. The prime bank lending
rate increased from mid-1994 to early 1995 to a high of 9.0 percent, then declined gradually to 8.25
percent in February, 1996. Acting to forestall a resurgence of inflationary pressures in 1997, the Fed
increased the Fed Funds Rate to banks, resulting in an increase in most banks' prime rate to 8.5% in
1997. Fed Fund Rates remained relatively constant at this level until the Fall of 1998 when a economic
monetary crisis in other areas of the world resulting in rapid recessions, loss of employment, monetary
devaluations and a quick drop in world equity markets.
Monetary turmoil in foreign economies and a rapid 20% decline in U.S. equity markets in the
Fall of 1998, brought on by perceptions of a slowing world economy, resulted in the U.S. Federal
Reserve dropping the Fed Fund rate by 75 basis points in late 1998 in an effort to stay off a world
recession and allow foreign governments to lower their interest rates, stimulating new investment and
spending, which would result in new growth, in deference to inflationary fears.
Moreover, concerns over world economic instability, resulted in many institutional investors
pursuing a "flight to quality" investment strategy. U.S. Government securities, perceived as the safest
investments in the world were purchased at prices yielding the lowest interest rates in 30 years. As of
mid January 1999 the U.S. Treasury "Long Bond" (30 year maturity) was near 5% with the 10 year bond
yielding only 4.50%. Although U.S. Government securities yielded their lowest rates in 30 years,
mortgage and corporate bonds did not fully benefit from a corresponding decline. Even with government
bond yields dropping to historic lows, concerns relating to a recession in the global economy and how
this might negatively impact both corporations and evidentially consumers ability to repay debt
obligations, kept mortgage and corporate bond rates higher.
The lowering of short term interest rates by the Federal Reserve in the Fall of 1998 and by
counterparts in foreign countries provided the needed stabilization to world economic markets and
brought new confidence to the equity markets, leading to a rebound in stock prices with the Dow
Industrial Average Index and the NASDAQ reaching new highs at the end of 1999. Continued
economic strength, high employment rates and moderate borrowing rates has once again lead the Federal
Reserve to once again refocus its attention on inflation.
To control possible renewed inflationary pressures in the U.S. economy, the Federal Reserve
made two quick, one quarter increases in the Discount Rate in the first half of 1999, resulting in
commercial banks increasing their prime rates by one half percent since the beginning of 1999. Once
again the Federal Reserve raised the Federal Discount rate in October 1999 and again in January of 2000
by one quarter percent each time, leading short term interest rates back to the same levels they were two
years prior. Recently, the Federal Reserve increased the discount rate by 75 basis points in two steps in
April and early May of 2000. With so many recent rates hike the Federal Reserve has left short term
rates static during the past months, but with an eye for further increases if the economy continues to
growth at too fast of a pace. Some forecasters believe that the Federal Reserve will not increase short
term interest rates prior to the November 2000 election, but any signs of continued rapid growth will
likely give cause for the Federal Reserve to raise rates again in the near term.
In the first quarter of 2000, the rise in short term rates also impacted long term fund indexes
with the long bond (30 year) rising nearly 150 basis points (1.5%) from January 1999 to over 6.6% in the
first quarter of 2000. This upward trend subsided somewhat by the second quarter of 2000, with the
long bond falling to a yield of 5.25% by August of 2000. The 30 year bond rate experienced somewhat
of an anomaly in the first half of 2000 as shorter term bonds, i.e., the 10 year bond demanded a higher
yield. This trend reversed itself in the summer months as 10 year maturities have now dropped to 5.75%
by the beginning of September of 2000.
Below is a chronology of changes in four leading interest rate indexes from 1993 through the
second quarter of 2000.
