How low might interest rates go?

• Author: Kurish, J.B.

Whether individuals, private businesses or public entities, borrowers of all types have enjoyed the extremely low interest rate environment of the past several years. As can be seen in Exhibit 1, the yield on 30-year Treasury bonds, a common measure of interest rate levels, has steadily declined for the past six years. In mid-August of this year, the 30-year Treasury was at a two-decade low of 6.30 percent. The average yield between 1980 and 1993 was 9.86 percent.

Among those borrowers benefiting from the low interest rate environment have been state and local governments. For example, a record amount of $235 billion in long-term, tax-exempt debt was issued during 1992. That number very likely will be surpassed by tax-exempt bond issuance in 1993. Through June, $145 billion of long-term, tax-exempt bonds have been issued. The boom in debt issuance in 1993 is very similar to what was driving the market last year--refundings of previously issued debt. In 1992, 50 percent of long-term debt issuance was for refundings. Through the first half of 1993, approximately 66 percent was for refundings. Many market observers expect the volume of tax-exempt refundings to decrease, however, based on the belief that most of the refundings that made sense on an economic basis already have been completed or will be completed in the months ahead. Of course, there is potential for an additional wave of refundings should interest rate levels continue to fall.

In addition to refunding possibilities, state and local government finance officials are keeping a keen eye on interest rate levels as they consider various capital financing plans. Some are contemplating moving financing plans forward to take advantage of the current low interest rates in the tax-exempt market. Others are exploring various forward financing plans that would allow them to lock-in today's attractive rates for projects that may not get underway for many months. Government finance officials on the investment side of the market also are interested in the future movement of interest rates. Their task of attaining high investment returns while ensuring the safety and liquidity of public funds has been made more difficult by low interest rate levels.

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