Understand how the Fed and global conditions add up for 2014
Bargain basement interest rates could spike sooner than many think, and if they do, farmers will feel the impact on everything from land values to competitiveness of exports. Interest rates are largely determined by the Federal Reserve’s monetary policy, and when the Fed speaks, markets get jumpy.
"The debate within the Fed will change next year," predicts Bluford Putnam, chief economist for the CME Group. "Tapering Fed asset purchases won’t be on hold in 2014. The Fed has to end this party."
"Tapering Fed asset purchases won’t be on hold in 2014. The Fed has to end this party."—Bluford Putnam, chief economist for the CME Group
As a result, he explains that the T-Bond will go back to its historical level of being 1% to 1.5% above inflation. That means farmers will pay higher loan rates.
Putnam, an admitted outlier on when quantitative easing (QE) will end, believes the No. 1 concern by the central bank in 2014 will not be the level of unemployment, the growth of the economy or inflation. Rather, front and center will be how the Fed untangles itself from the $3.8 trillion in assets it now owns. That’s nearly five times greater than the Fed’s $800 billion in assets in 2008, prior to central bank efforts to prop up the sagging economy.
Because of shifting focus at the Fed, Putnam thinks interest rates are likely to increase. Not only will rates be higher, but volatility will put them more in line with historical trends, Putnam believes. In 2008, interest rate volatility spiked 12% and then gradually fell to 3% with the Fed’s QE program.
Looking ahead, bond volatility will likely move up toward 5% or 6%, while equity volatility might move from the current low levels of 12% up toward 15% to 20%, he says.
Putnam is not critical of the Fed’s action early on. "It saved us from a depression," he says, noting the Lehman Brothers bankruptcy. But now the Fed has a major problem because it owns assets equal to about 22% of one year’s GDP compared to the pre-2008 figure of 6%. At its current rate, the Fed would own the equivalent of one-half of one year’s GDP within five to six years.
Putnam also says there’s potential for inflation to rise to 3% to 4% but not until 2016 or later, so producers might have a few years to prepare. However, he acknowledges that it will require a credit binge to spur inflation, and even if consumers begin borrowing, there will be a lag.
Across Continents. Another critical factor producers should be aware of is the growth rate of China. Growth has already declined from 10% per year beginning in the 1990s to 2010, to about 7.5% now.
"China is probably headed for 4% growth during the next decade," says Putnam. He sees the possibility for a serious real estate problem in China. However, its economy is so tightly controlled that Putnam believes they could escape real estate problems without a large economic impact.
"There are going to be some losses, but there won’t be that much of a decline in demand for U.S. ag products," he says.
On the flip side, China’s arable land is decreasing as it transitions to a more urban population using passenger vehicles, explains Philippe de Lapérouse, managing director for HighQuest Partners. By 2030, he says China’s land use by passenger vehicles alone is forecast to equal 23% of the nation’s arable land, compared to just 3% in 2010.
Looking elsewhere, Putnam says that Europe’s economy is better in a relative sense—stagnant, but not getting worse. "Europe’s big problem is not austerity; its banking system is undercapitalized," Putnam says. "Banks still have too many troubled assets." This means they have limited lending ability.
As for the U.S. dollar, he doesn’t foresee a quick turnaround, which bodes well for keeping U.S. ag products competitive. "The dollar is on a weaker plane," he says.
Demand for Land. Putnam expects corn prices to remain volatile during the next 12 to 18 months, but he says the move to the downside has already occurred.
Lapérouse agrees."We won’t see commodities revert back to historical levels," he says. "There’s a lot of talk about the end of the commodity super cycle, but soft commodities might have softer legs than hard commodities, such as corn and soybeans."
He also expects continued volatility. Even as grain stock levels have increased, they are far lower than past eras. This makes feed grains more vulnerable to droughts and global events.
- December 2013