Farmers eye interest rates
Farmers have enjoyed low interest costs since 2008 when the housing and financial collapse caused the Federal Reserve to slash rates to near zero.
But farmers should not take cheap money for granted, as rates will eventually rise. With interest rates low, by default the next move is up. Advisers suggest being ready for it.
For several years now, retired economics professor Edmond Seifried has been traveling the country to warn farmers of higher rates. But on August 9, he had to moderate those warnings when the Fed made the unprecedented announcement that it would hold interest rates “exceptionally low” through mid-2013.
“It was a two-year reprieve for farmers,” says Seifried, a partner in the Pennsylvania bank consulting firm Seifried & Brew. “I call August 9 Farm Freedom Day.”
The Fed's statement came just one day after the stock market suffered a sharp one-day loss. The message was meant to soothe jittery markets and instill confidence in the economy. The wording was unprecedented, say Fed watchers, because the central bank had never before used such a specific date. Typically, the Fed will merely say that it intends to hold rates low for “an extended period.”
“The announcement basically lifted the burden of worrying about a sharp rate increase that's surely coming in the future,” says Seifried. “Rates can't stay this low forever, and farmers should not get used to these low levels.”
In about 150 speeches a year to farm groups, Seifried warns that interest rates will eventually have to return to “where they should be.” He calls this natural rate equilibrium. An equilibrium level, he says, would be determined by free-market forces, without the artificial influence of the Federal Reserve.
“Farmers should not take cheap money for granted.”
Seifried warns farmers that the natural equilibrium rate for farm loans should be around 8% to 9%. That level is made up of three components.
1. Savers won't deposit their money for nothing; they want to be paid. Seifried suggests 2% to 3% as a minimum market-based rate.
2. Because loans are repaid in the future with cheaper dollars, interest rates have to account for inflation. That adds another 2% to 4%.
3. You have to add the lender's profit and overhead. He figures it all adds up to about 8% to 9% by the time it is lent to farmers.
As farmers entered this fall's harvest, ag loans were running around 3.4% to 5.3%, depending on the term and whether the rate was variable or fixed. Four years ago, rates were closer to 7%.
Maturity of government securities
With the Fed's August 9 announcement, it looks like rates will stay low for a while. But Purdue University agricultural economist Mike Boehlje warns that the Fed is not obligated to stick to its announced plan.
The Fed could raise rates at any time if employment and economic activity start to pick up. In fact, says Boehlje, the Fed would like nothing better than to raise rates, as that would be a sign of an improved U.S. economy.