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Raising Interest Rates: Heartaches by the Number

Will interest rates be raised? If so, when? That’s been a nagging issue on the minds of farmers and lenders for months.

“The question on the table is, when will the Fed raise rates?” says Esther George, president and CEO of the Federal Reserve Bank of Kansas City.

The federal-funds rate (the interest rate at which a bank lends funds overnight to another bank) has hovered near 0% since December 2008, when the U.S. was in the grip of the financial crisis. The last time the Fed’s target rate was raised was in 2006. You’d have to go back to 2008 to find interest rates above 6% (see the graph below).

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The Fed’s three prerequisites for an increase are price stability, full employment, and financial stability. Federal Reserve Bank chair Janet Yellen has indicated that a rise would be “appropriate” by year-end.

Many Fed members agree, saying that higher interest rates would restore a recession-fighting tool in its arsenal. Savers, especially retirees, are also being hurt. 

“The language has shifted from ‘patient’ to ‘data-dependent,’ ” George says. “No matter when it happens, in my view, it’s time. The sooner we start, the more options we’ll have for a gradual move. Waiting for an all-clear signal raises a risk of other issues arising.”

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However, the strong dollar, China’s currency devaluation, falling oil and import prices, and a sluggish jobs report caused jitters in the financial markets last fall.

Many argue that the U.S. is in a low-inflation, low-demand environment that doesn’t require the Fed to raise its rates. Consumer inflation has been running at about 0.2%, below the historic norm of 3.2% a year.

Regardless of what happens and when, there’s no question that ag profitability during the past decade has allowed farmers to finance much of their short-term credit with cash flow. As record profits continue to recede, credit demand will be increasing proportionately.

A higher rate by year-end or in 2016 will impact short-term borrowing rates. Long-term rates already have risen by .25% to .50%.

Brent Gloy and David Widmar of Agricultural Economic Insights anticipate an increase of 100 basis points into 2016. For a cash grain farmer who finances $400 per acre of operating expenses, this increase would add $4 per acre in costs. Factoring in a 4% borrowing rate, the interest tab would increase from $16 to $20 per acre. This rise would also dampen the enthusiasm for agricultural equipment purchases.

“Our view is that interest rates aren’t likely to rise enough in the short term to cause large decreases in profitability,” says Gloy, a former Purdue University professor who farms in western Nebraska. “Overall, it’s not likely that interest rate increases on non-real estate loans will place a huge burden on producers in 2016. However, it adds another cost to the ledger at a time when significant cost reduction is required.” 

Terry Jones of Executive Ag Network and a Williamsburg, Iowa, farmer  agrees. “People have gotten very forgetful about higher interest rates and what impact an increase would have on their operating line of credit, their debt, and costs of production,” he says.

Low Rates Buoy Land Value
Most non-real estate credit is financed with floating rate loans, so a Fed rate rise would be felt there first. (See the graph below, based on the Ag Finance Databook.)

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Gloy says the share of loans with floating interest rates has remained near 75%. This means about 75% of non-real estate loans are subject to an adjustment if rates are lifted.

At banks, about 74% of non-real estate loans have floating rates. According to Kansas Farm Management Association estimates, 48.6% of debt is at a fixed rate. So, only about 50% of this debt would be affected by an interest rate change.

The portion of fixed-rate real estate has hovered at about 83% for Farm Credit Services of America.

The unequivocal impact of low interest rates on farm balance sheets has been supportive of land values.

“From an equity standpoint, low rates have kept land values fairly high,” says Charles Brown, Iowa State University farm management specialist. “However, in 2015, land values in Iowa have decreased 11%.”

The USDA’s downward adjustment of its 2015 farm net income forecast to $58.3 billion also changes the debt-to-income ratio. Farm debt is expected to grow by 5.8%. Given the drop in assets and rise in debt, the USDA forecasts that ag equity will fall by 4.8%.

“Farmers may want to consider 2016 losses and prepare by moving debt around so they might manage likely higher interest rates better over time,” says Kelvin Leibold, Iowa State University farm and ag business management specialist.

Strong Dollar is a Drag
The old adage, Low prices cure low prices, rings true today says Naomi Blohm, senior market adviser for Stewart-Peterson. “Buyers recognize good value, and in the wake of low grain prices, domestic demand has stayed strong.”

However, low prices alone aren’t enough to entice global end users. “Currency value plays a subtle role that U.S. producers need to be aware of,” she says.

The dollar is at its highest peak in over a decade. USDA trade analysts expect a $12 billion year-over-year decline in U.S. ag exports in fiscal year 2015.

“When our dollar is strong or higher, it makes U.S. commodities more expensive for other countries to import, due to the currency exchange rate,” Blohm says. “So even though the price of corn, soybeans, and wheat was significantly lower this past year, we saw reduced export demand from previous years. When export demand is reduced, it’s reflected in larger domestic supplies or larger ending stocks, keeping grain prices subdued.”

In the late 1990s and early 2000s, the U.S. dollar index was higher than today, trading between 100 and 120. U.S. exports of corn were lower, due to the higher dollar. Annual corn exports during that time ranged from 1.55 billion bushels to 1.85 billion bushels.

“Fast-forward into the mid-2000s,” Blohm says. “The U.S. dollar was at its lowest in 2007 and 2008, trading in the low 70s. Our corn exports those two years were between 2 billion bushels and 2.5 billion bushels. Now we have a U.S. dollar consolidating between 90 and 100. A recent USDA report pegged current corn exports at 1.85 billion bushels. If the U.S. dollar index pushes above 100, look for exports to slide lower, resulting in higher domestic supplies and higher ending stocks, which keeps the bears in price control.”

A report by Rabobank Food and Agribusiness Research and Advisory group senior analyst Steve Nicholson details the dollar’s rise. He points to about a 5% increase in current soybean futures prices, compared with last year’s harvest lows. “If you convert that to reals per bushel, the Brazilian farmer has seen over a 50% increase in the value of soybeans,” he says. “As a result, Brazil may increase its soybean acreage 4% to 6% this year, forcing U.S. prices and basis down just to be competitive in the global market.”

Leibold agrees. “Producers in other parts of the world aren’t getting the same message as U.S. farmers,” he says. “When you look at rubles and reals, grain prices still are strong. Farmers in these countries would like better prices, but they’re still winning the margin war. Exchange rates are the bottom line. They think margins are good enough to shift their production from wheat to growing more corn and soybeans.”

As you wrap up harvest, Blohm advises you to consider macroeconomic factors in relationship to potential marketing moves. 

“Keep an eye on announcements from the Fed regarding raising interest rates and global economic conditions,” she says. “If the U.S. dollar rallies, it might keep nearby corn futures prices in the upper $3 range. If the U.S. dollar falls, then that will help to keep corn closer to the low $4 price range.”

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