The Fed is likely to begin raising interest rates in September, but the pace of those hikes may be so gradual that producers may not notice much impact, depending on their farm's financial situation.
“It will be a slow process. Inflation remains fairly muted,” said Ernie Goss, a professor of economics at Creighton University in Omaha. “After September’s rate hike, there could be another rate increase in December, and then another in the first quarter of next year.”
If each of those three hikes in the federal funds rate is 25 basis points, the equivalent of 0.25 percent on the prime rate, producers borrowing money based on prime would pay 0.75% more interest annually on their short-term loans, including operating and vehicle loans.
American Farm Bureau Federation Economist Bob Young noted that the Federal Reserve might only increase rates by 10 basis points in September, which would mean the prime rate would only increase 0.1 percent.
“The rate that folks are paying at Farm Credit may not move right away,” Young said. “After about three to six months, the full bump might be reflected. The commercial market might not respond as quickly as prime.”
Farm Credit operating loans such as long-term rates are based on the commercial market, which this week was 3.85% , or 0.35% above prime.
Those producers who need a loan will feel the interest rates increases first. “We are going to have to pay more money to finance debt,” Young said. “As real estate loans begin to rise, probably in 2017, land prices will start to fall.”
Long-term rates don’t always follow increases in the federal funds rate and may even run in the opposite direction from short-term rates. For example, if Greece and Puerto Rico were to default on their debt, Goss said, long-term interest rates would go down as investors look for safe-haven investments, namely U.S. Treasury bonds.
Typically when the Federal Reserve begins raising rates, it does so in a fairly consistent pattern.
“I can’t envision that happening this time, though,” Goss said. “The economy is just too weak, and wage growth and inflation are too low.”
Interest rates have been notably low for six years, and the prime rate has been stuck at 3.5% since December 2008. By comparison, since 1949, the prime rate has ranged between 2% and 20.5%, averaging 6.7% for the entire 66-year period.
“If I were a farmer, I would protect myself against rising short-term rates by locking in these very low long-term rates. (I would) take out equity on the farm, understanding that I may be using the funds for operating,” Goss said.
Young says having a cash reserve going forward and limiting the amount borrowed will be crucial to keeping costs low.