Financial Markets


   The Wilshire 5000 (a broad stock market index) increased 13.9 percent during 2006, while the Standard and Poor 500 (an index of the 500 largest corporations) increased 13.6 percent. This was the fourth consecutive year of stock market gains following 3 years of declines. The market has now recovered most of its losses since the March 2000 peak, at least in nominal terms.

   Despite increases in short-term rates, yields on 10-year notes remained low, increasing only 9 basis points during the 12 months of 2006. The low level of long-term interest rates was due in part to low and stable long-run inflation expectations.

   The Administration forecast of short term interest rates is roughly based on financial market data as well as a survey of economic forecasters. As of November 13, 2006, the date that the economic forecast was finalized, trading in financial futures suggested that market participants expected shortterm rates to fall over the next several years, and the Administration's interest rate projections reflect those views. The Administration projects the rate on 91-day Treasury bills (5.1 percent on November 13 ) to remain flat in 2007 before edging down in 2008 and 2009. The short-term rate is projected to fall to 4.1 percent by 2012. At that level, the real rate on 91-day Treasury bills would be close to its historical average.

   The yield on 10-year Treasury notes on November 13 was 4.61 percent, 48 basis points below the discount rate on the 91-day Treasury bills-a noticeable reversal of the usual pattern which shows higher rates for long-term yields. The Administration expects the 10-year rate to increase above the 91-day rate during 2007, eventually reaching a more normal spread of about 1.2 percentage points by 2010. An increase of a similar magnitude appears to be expected by market participants (as evidenced by higher rates on 20- and 30-year Treasury notes than on notes with 10-year maturities). As a result, yields on 10-year notes are expected to increase somewhat further, reaching a plateau at 5.3 percent from 2010 onward.