(FORTUNE Magazine) – THE CREDIT MARKETS have fairly fibrillated so far this year over the prospects for interest rates -- and particularly about the future course of Federal Reserve policy. Investors have reacted to each new economic statistic as if it provided the vital clue to the general business outlook, freighting the monthly readings with far more meaning than they can bear. For all the anxiety, though, rates have gyrated within a fairly narrow band since the Fed stopped easing early this year. Early reports did seem to indicate faster-than-expected economic growth. Combined with weakness in the dollar, that expectation pushed rates up during February and early March (see chart). Then economic forecasts turned more pessimistic -- perhaps too much so -- and rates sagged. Gauging by inflation-adjusted GNP alone, the U.S. economy has been in a so- called growth recession since the middle of 1984. According to Geoffrey H. Moore of Columbia University, the foremost expert on business cycle measurement, this rather esoteric state is a period of below-average economic growth that lasts more than six months. But so far most other measures of activity haven't been weak enough to fill the complete bill. Moore thinks this period could yet turn out to be the fourth postwar growth recession -- the other three were in 1951-52, 1962-64, and 1966-67. But since by definition such periods are just breathers in the economy's climb, that wouldn't be scary at all. Recent economic news portends some speedup, but growth seems likely to be moderate in the quarters ahead. Total hours worked increased at a 3% annual rate in April from the first-quarter average, but industrial production barely budged. Retail sales picked up again in April after a disturbing decline in March. Consumers don't seem about to go on any spending sprees, but they are still making a contribution to economic growth. Though April housing starts hit an impressive 1.9 million annual rate, permits slipped, suggesting fewer gains -- or even declines -- in the future. The worst of the increases in the trade deficit are probably behind us (see next story), but any gains to the economy will be offset as business pares the buildup of inventories. The Administration's expectation of 4% growth in inflation-adjusted GNP for 1985 seems increasingly futile; FORTUNE sticks by its January forecast of 2.5% growth. Many of Wall Street's Fed watchers have been bewitched by movements in the Federal funds rate -- interest charged for reserves that banks lend each other. Over two or three months the funds rate is one moderately useful indicator of policy, but its twitches -- often the result of happenstance rather than policy -- have led many people astray. Other indicators of policy -- the various reserve and money supply figures -- have provided conflicting signals. Early in May, Chairman Paul Volcker, in a highly unusual move, told the Senate Banking Committee that the Fed has been holding to a fairly steady course since the beginning of the year. So Volcker clarified the recent policy stance, but of course didn't reveal what the Fed would be doing in the future. In mid-May the Fed lowered the discount rate from 8% to 7.5%; the rate had been closer to the Fed funds rate than usual for this stage of an expansion. Still, the Fed doesn't seem likely to change its policy of restrained accommodation, since the economy will grow only moderately. And credit demands will keep interest rates from breaking much, if at all, below the narrow band of the past half year. Congress's efforts to cut $50-odd billion of spending for fiscal 1986 are encouraging, but with major conflicts unresolved, the final budget is not likely to be down that much. The deficit will probably end up close to $200 billion, providing little relief to the credit markets. The troubles of the privately insured S&Ls in Maryland haven't had much impact on interest rates and aren't likely to. The premium rates on bank CDs over Treasury bills, one measure of confidence in the financial system, have held at half a percentage point this year, down from nearly 1.5 points in the midst of the Continental Illinois turmoil last year. Indeed, in recent weeks interest rates in general have returned to the bottom end of the 1985 range. Wall Street may still be buffeted over the next few quarters by those nervous fluctuations in rates. But assuming the dollar continues to decline only gently and doesn't collapse, business can count on trudging along with interest rates about where they have been recently.

CHART: TEXT NOT AVAILABLE