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Interest rates: looking up?

DANIEL LOOKER 11/15/2013 @ 11:49am Business Editor

The Federal Reserve's unprecedented intervention in the economy and how it unwinds will ultimately affect interest rates farmers pay for long-term and short-term loans. But forecasting how fast and how high the expected increases will be can be a hazardous business.

Rob Sabo works every day in the derivatives market at Rabobank Global Financial Markets in Chicago, where he helps borrowers deal with both commodity price volatility and interest rates.

Earlier this week the executive director of Global Financial Markets for Rabobank spoke to borrowers at the bank's Agribusiness Summit in St. Louis, sharing insight into how the market views the outlook for interest rates.

Sabo made it clear that he's not forecasting rates. In fact, he can't, because of both bank policy and regulations.

In the past five years, the Fed has made the largest single intervention in the financial markets by any government in the history of the world, Sabo said. The purpose was to drive down interest rates, "to try to generate some kind of economic activity because things were dead in the water."

The Fed used well-established tools, including influencing the federal funds rate, which is what banks charge each other for overnight loans of funds maintained at the Federal Reserve. No one who farmed in the late 1970s and early 1980s has forgotten the funds rate that peaked at 20% under Federal Reserve Chairman Paul Volcker.

In November of 2008, under Chairman Ben Bernanke, the Fed announced a $600 billion long-term bond purchase. It was the start of what became known as quantitative easing.

By purchasing 10-year treasury bonds and mortgage-backed securities, the Fed also drove down long-term interest rats. The yield on 10-year Treasuries fell from 4% to 2%.

"They dumped $4 trillion into the market," Sabo said.

But Sabo sees the Fed's influence over the bond market, which influences long-term interest rates, as less certain than the short-term rates influenced by the Federal Funds Rate.

One writer has compared the long-term and short-term interest rates to two adopted children living in the same household, Sabo said.

The market decides long-term rates, Sabo said.

This year, every time it appeared that the Fed would phase out of its intervention in the bond markets (dubbed tapering), yields rose. One survey of economists showed that they expected bond yields to be back at about 4% in a year, he said.

Bond yields have been volatile, and when rates start to rise, it may not be smooth, he said.

"We're in uncharted waters," he said. As bond yields increase, "I think you see chunks," not a gradual rise, he said.

"The Fed doesn't want that, but I don't think they can stop that," he said.

Short-term rates, which the Fed has more control over, aren't likely to be rising soon, if inflation remains low and unemployment is slow to decline, and if the next Fed chairperson, Janet Yellen, is as dovish on rates as many expect.

But Sabo reminded his listeners of the power of the Fed to change that. He showed a chart summarizing the Fed's actions under Volcker: 33 interest-rate increases over 3.25 years, running the Fed Funds Rates from 4.75% to 20%.

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