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Clues to the interest rate mystery

All cards are in play right now as grain markets, weather
and the U.S. Dollar index are up in the air, and all influencing the
long-awaited sign of a change in the current historically low interest rates.
 

Before data from next week’s USDA acreage and grain stocks
is reported, many are placing their last bets on the future of the economy and
how it will affect farm loans.
 

"We know it is just a matter of time until interest rates rise.  Grain production will expand significantly this year...A good crop year worldwide will let some of the air out of the grain price bubble and the resulting land bubble.  Two good years will be the end of the high priced binge for grain farmers and will result in some bad hangovers," Farm Business Talk member, fernwood, predicted.

The Federal Open Market Committee (FOMC) met this past
Tuesday and Wednesday to discuss the current state of federal funds.  The FOMC released a statement saying, “The
slower pace of the recovery reflects in part factors that are likely to be
temporary, including the damping effect of higher food and energy prices on
consumer purchasing power and spending as well as supply chain disruptions
association with the tragic events in Japan.”  The Committee decided to keep the target range for federal
funds rate at 0 to .25 percent and is foreseen to stay low for an extended
period.
 

Current economic events in Greece, numbers from the internal
housing market and unemployment rates all continue to disappoint, raising
concerns that economic growth may not happen as quickly as expected.  As a result, the million-dollar
question remains whether the lull is a temporary issue, or whether the economy
is headed for a double-dip recession as suggested by Yale economist Robert
Shiller.

So where does this leave farmers?  According to Paul Ellinger, Agricultural Economist at the
University of Illinois, the FOMC policy implies that interest rates on farm
loans will remain low for the next few months.  “The average interest rate on loans to farmers from banks
with agricultural portfolios greater than $35 million was 3.89 percent in the
first quarter of 2011.  Almost 50
percent of the loans made to farmers were less than 5 percent while over 75
percent were less than 6 percent,” he said.

Risks for borrowers continue to hint at major debt problems
than would exist under normal interest rate conditions.  The rule of thumb remains that interest
costs on farms should not exceed 20 to 25 percent of gross farm income.  Both interest expense as a proportion
of value of farm production (VFP) and interest coverage—the number of times a
farm can make interest payments on its debt with its earning before interest
and taxes--measure the ability of a business to meet debt obligations.  Ellinger reported that both measures
show Illinois farms, on average, have an increased ability to meet debt
payments over the past decade.  “The
median [interest coverage] measure exceeds 12 in 2010 while only 25 percent of
FBFM farms have interest coverage levels below 5.7,” he said.

These findings imply farm operations are currently
financially healthy, but a change in tide is still inevitable.  Evaluating the impact of a change in
interest rate on farm operation is highly suggested.

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