Remaining Resilient Amid Rising Interest Rates

After pausing in June, the Federal Reserve raised interest rates a quarter percentage point in July, and Fed projections point to another hike this year. Our senior rural economy analyst, Matt Clark, recently spoke with Brownfield Ag News about how farmers can respond to rising interest rates and protect their bottom line. A former Federal Reserve Bank employee, Matt:

• Offered a course of action for those with variable-rate operating notes
• Discussed key considerations for savers looking to take advantage of higher interest rates
• Revealed what economic indicators he keeps a close eye on in uncertain times like these

The full recording of Matt’s interview is available online: https://brownfieldagnews.com/news/variable-rate-farm-loans-reflecting-rate-hike/

How Rate Hikes Affect Farm Lending

In its fight against inflation, the Fed has raised the federal funds target range to 5.25% to 5.5%. The biggest impact from the Fed’s moves on rural and farm communities, Matt says, is on the operating side, because most operating notes have variable rates. “Those operating notes almost always reset up or down with the Fed. In this case, really since the beginning of 2022, they’ve been in…almost a straight linear upward trend for the most part.” The Federal Reserve Bank of Kansas City estimates that more than 78% of non-real estate farm loans made in the second quarter of 2023 were on a variable rate, and the average rate in the second quarter was the highest level since 2007.

Significance of Higher Rates

Combined with other inflationary expenses inside operating notes, Matt says, higher interest rates are making for a tighter situation than in previous years. To assess the significance of these rate hikes, Matt looks at the USDA’s interest expense ratio. “It’s always hard to think about individual interest rate moves because typically on most farms, there’s a portion of rates that are fixed, whether that’s a real estate note, maybe it’s a note for a combine or a truck or a tractor or something like that. And then there’s the variable portion. I like to follow the interest expense ratio because it kind of encapsulates all those.”

As of late July, the interest expense ratio was .06, which according to Matt is the highest it’s been since the early 1990s. “That is to say that these hikes, for the most part, from 2022 through now, have been pretty impactful to farmers.” For context, the average interest expense ratio from 2013 to 2022 was 0.039.

Thoughts for Farmers With Variable-Rate Notes

For those who have operating notes with variable interest rates, Matt suggests these steps:

1. Sit down with your Farm Credit lender and stress out the potential views of where you think interest rates could go over the next year. For example, what would your income look like if rates increased by another 25 basis points? What if they increased by 50 or 100 basis points, or even decreased by 25 or 50 basis points? This will help you understand your maximum tolerance and risk levels.
2. From there, make an action plan with your Farm Credit lender to set your rate strategy at the thresholds you are comfortable with. Just like pricing corn, Matt says, you should look at when you would want to lock in or float an interest rate price.

Considerations for Savers

On the plus side, higher interest rates mean those with cash on hand could build up their income a bit through a lower-risk savings product. Before tying up available funds, though, Matt suggests these exercises:

1. Work through your cash flow for the year with your Farm Credit lender and make sure you’re covered. Think through the possibilities of being able to move income in and out of your savings product for opportunities that come up, such as purchasing land. You wouldn’t want to lock into a savings product that makes accessing your money difficult when opportunities arise.
2. Think through a balance of safety versus risk. Although most savings products are relatively safe, they also have a lower return on investment. Work through the cost-benefit with your Farm Credit lender and finance team.

Two Indicators to Watch

July’s rate hike might not be the last this year, as Matt noted the Fed’s most recent projections, often referred to as the dot plot, for the rest of 2023 indicate one more hike. As we approach the September meeting, when the Fed could raise rates next, there are two things Matt is watching: the labor market and the PCE (Personal Consumption Expenditures) inflation report.

Both are related to the Fed’s goals of maximum employment and price stability. In terms of employment, Matt says, “we’ve got what I would consider to be a really hot labor market.” At the time of the interview, Matt was expecting the next unemployment report to reveal a 3.6% or 3.7% jobless rate; the report came in hotter than expected at 3.5%, which is even lower than the pre-COVID average in 2019 of 3.7%.

Regarding price stability, he pointed to a recent reading from the PCE that was “relatively positive, [in that it showed] some slowing in inflation.” But, Matt cautioned, the Fed is still very committed to getting inflation down to its 2% target. “It seems more probable than not that we would still have an aggressive Fed on interest rates.” While that may or may not mean additional rate hikes, it does mean that the Fed is very unlikely to start cutting rates or easing monetary policy.