Money gets more expensive

Here’s what higher interest rates mean for your farm

Farmers are watching yield monitors for insight about the size of 2017 crops. On Wall Street, investors will keep rapt attention on the Federal Reserve for clues about how far and how fast interest rates will be rising over the next few years.

The Fed’s next two-day meeting on monetary policy wraps up Sept. 20. Unless the pace of economic growth picked up noticeably in the second half of summer, no change in the central bank’s core short-term target for interest rates, known as Federal Funds, is likely. Comments by officials and their projections could spark debate about whether the Fed will even increase rates another quarter-point in December, or hold off until March or later.

Inflation is a key metric to watch. It stayed stubbornly below the Fed’s 2% target in 2017. One of the bank’s twin goals has been reached: low unemployment. But its other mandate, price stability, won’t be met until inflation picks up from an anemic level. Some economists believe raising rates too quickly could stifle growth, perhaps renewing talk about the dangers of deflation.

Farmers, of course, could teach those economists plenty about commodity deflation; the ag sector suffered through that the last couple of years. But one obstacle growers haven’t faced is high interest rates. The cost of money has been cheap since the Fed slashed rates during the financial meltdown of 2008-09.

Interest rates are nowhere near the 22.4% top, hit in the days of double-digit inflation in the 1980s. But if Fed officials hold to their most recent projections, short-term rates could rise another 1% by the end of 2018. That would raise the Federal Funds rate from its current level of 1.1% to 2.1%. The so-called prime rates big banks charge their best customers would go up to 5.25%, with average farm operating loans topping 6%.

Impact on costs may not be great at first. USDA’s Economic Research Service puts the increase in operating interest expenses from 2017 to 2018 at 65 cents an acre for corn and 34 cents for soybeans.

That’s just the start, however. Interest on CCC loans is pegged to these short-term benchmarks. Loans taken out at harvest this fall should be a half-point more than in 2016 and will track higher in 2018. The cost of storing $3.50 cash corn for nine months could go up 2.5 cents due to higher rates on CCC and operating loans.

And that’s just the impact of short-term rates. The Federal Reserve controls those charges directly. Longer-term rates used on machinery and land loans are set by the market, which follows yields on U.S. Treasury notes and bonds.

Rates on the benchmark 10-year note actually were lower this summer than at the start of the year. The Fed’s September meeting will address long-term rates too, though somewhat obliquely. The Fed doesn’t directly control these rates, but can affect them.

When slashing short-term rates near zero didn’t jump-start the economy, it embarked on “quantitative easing.” To hold down long-term borrowers’ costs, the Fed added trillions to its balance sheet by buying government and other securities from the market. That reduced the supply of these instruments, driving up their prices. Interest rates move in the opposite direction of prices, so this kept long-term rates lower than they would have been otherwise.

At its last meeting, the Fed hinted it would begin unwinding its holdings in September. Removing a source of demand by not buying as many new securities should reduce their price, raising long-term rates, albeit slowly.

That could affect interest payments on term debt in the coming year. It could also impact land values.

One value of real estate is based on its capitalized value. This compares the expected return from the parcel, say in cash rent, to interest rates on a safe investment like 10-year notes. Increasing yields on these from 2.3% to 3% would slash 25% off the theoretical value of land that rents for $235 an acre.

Ultimately, land is worth what someone will pay for it. But the calculation is another sign farmers should pay attention when the Fed talks.

Decision Time: Risk Management is independently produced by Farm Futures and brought to you through the support of Case IH.

 

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