NEW YORK -- With six interest-rate increases in 1994 one might wonder: Is the Federal Reserve having any success in slowing the economy?
By the usual measures of growth and unemployment, the economy doesn't seem to have gotten the message. It just keeps getting stronger, apparently ignoring the Fed boosts meant to stave off potential inflation.
But, in fact, the seeds of slowdown "are" taking root, according to a study by the Securities Industry Association, the trade group for brokerages and investment banks.
It might be too soon to see the results in widely watched figures such as employment statistics, the SIA says, but the "capital markets" farther back in the pipeline show patterns like those that preceded past economic slowdowns and recessions. The bottom line, the study forecasts, is that securities firms will earn $6 billion less this year than in 1993.
"If the capital markets are affected, you can be sure that the real economy will be affected," SIA research director Jeffrey M. Schaefer said in a recent interview. "Maybe not at the same time, but certainly it will be affected in the same direction."
Historically, says Mr. Schaefer, downturns in the capital markets -- stocks and bonds -- are followed six to 12 months later by downturns in the manufacturing and service-producing machine that provides jobs, sets wages and determines prices for things Americans buy and sell.
Rising interest rates, courtesy of the Fed, have made this the worst year for the securities industry since 1990, with the average profits for brokerage firms dropping 80 percent below the record levels of 1993, according to an SIA survey. The association estimates that the industry will earn less than $1.8 billion in 1994, compared with $8.6 billion last year.
The largest part of that decline is the result of losses on bond investments: As interest rates went up, the value of bonds owned by securities firms went down. The SIA estimates that bond investments lost $1 trillion between January and mid-November, equal to the losses in stocks during the 1987 crash.
Another cause of earnings drops for brokerages was the deep decline in underwriting, or the sale of newly issued stocks and bonds, for which securities firms receive generous fees. Rising interest rates mean that companies are cutting back on issuing new securities.
The total value of new corporate bond underwritings is 24 percent below last year's record pace, and the value of new stock issues is down 39 percent, the SIA says. Underwriting revenues for bonds alone are down $3.8 billion this year.
That means companies are raising less money to finance expansions, a condition that has preceded previous slowdowns
in the economy as a whole, Mr. Schaefer said.
Consider corporate bonds, which companies sell as a way of borrowing money. The issuing company pays interest every six months to the people who buy the bonds. After a set period, the bond matures and the issuer returns to the investor the money paid for the bond. For the issuer, the cost of borrowing is the interest it pays. As interest rates rise, so does the cost of borrowing.
In the late 1980s, the capital markets turned sour. The value of new corporate bonds issued flattened. The value of new secondary-stock issues -- securities offered by firms whose stock already is traded publicly -- declined. And the value of initial public offerings dropped. The recession of the early '90s followed.
During the recession, the Fed brought down interest rates. The capital markets flourished, and the current recovery followed.
From 1991 to 1993, interest rates were going down, making it cheaper for companies to borrow money by issuing bonds. So companies issued huge amounts of bonds to pay for expansions or mergers, or to pay off older debts that carried higher interest rates.
In 1990, a record $291 billion worth of corporate debt was issued, the SIA says. Last year, with some interest rates hitting their lowest levels in decades, the total value of corporate bond issues was more than three times that level, $921 billion.
But as interest rates rose this year, it became more expensive to issue corporate bonds. By year-end, the SIA expects about $697 billion in new debt issues, 24 percent less than last year.
With less money to finance expansion, companies are less likely to hire new workers. That means there will be less pressure to raise wages. In theory, that makes inflation less likely.
Higher interest rates also have had an effect on corporations' ability, or willingness, to raise money by issuing new shares of stock.
As rates go up on fixed-income investments such as bonds, money market accounts and certificates of deposit, those securities begin drawing investors away from stocks, causing stock prices to fall.
Between February and mid-April, the Dow Jones industrial average, the most widely watched indicator of stock prices, dropped more than 8 percent. It's still about 4 percent below its late-January high for the year. Last year, it went up more than 15 percent during the year.
The lower the price of a stock, the more shares a company has to sell to raise a set amount of money. That means shares already owned by investors are diluted -- each share earns a smaller share of company profits and has less voting power at the annual meeting.
So when share prices drop, companies are less likely to issue new shares to raise money.
In the late '80s, the total value of new shares of stock issued dropped in half, from $57 billion worth in 1986 to $24 billion in 1990. It was a time when interest rates were rising and the stock market was hammered by the '87 crash. The recession followed.
In the early '90s, interest rates fell, stock prices perked up, and the value of new stock issues soared to a record $131 billion. This year, interest rates rose, stocks languished, and the total value of new-stock issues has fallen to the 1991 level, a projected $80 billion for the year.