Policy Punch

October 3, 2013 09:57 PM
Policy Punch

The Federal Reserve’s monetary tightening will add to farm pressures

On Sept. 18, the Federal Reserve stunned financial markets by saying it will postpone the tapering of its monetary easing stimulus plan, which pumps $85 billion each month into the U.S. economy. This news doesn’t take the tapering off the table. It will still happen, it’s just a matter of when.

When this occurs, it will have enormous repercussions for not only the general economy, but also for farmers. Producers will have to pay more to finance their operations through higher interest rates once the Fed’s tapering is a reality. It will also likely pressure farmland values and the strength of the dollar.

Keith Leggett, American Bankers Association senior economist, says that just the mention of tapering has caused long-term rates, such as those for farmland, to increase more than one percentage point. Actual tightening could easily add another percentage point by next summer.

Leggett doesn’t expect short-term rates to increase until 2015, but once the Federal Reserve begins tightening, short-term rates could raise up to two percentage points within a year.

Pressures Add Up. "The combination of increased interest rates and lower commodity values could put downward pressure on land values," says Paul Ellinger, a University of Illinois ag economist. "I don’t expect to see an actual decline but more of a leveling off, although a decline could occur in some markets."

Brian Briggeman, a Kansas State University ag economist, agrees with Ellinger, saying that he doesn’t expect to see anything like the 1980s.

Today, interest costs represent less than 6% of total costs. Unlike the 1980s, farm equity and balance sheets are in a good position to withstand a rate increase.

While all macro factors affect farmers’ bottom lines, the Federal Reserve’s decision to reduce monetary easing is one of the biggest.

"Agriculture has benefited, despite the weak U.S. economy the last several years," Leggett says.

Courtesy of the Fed and a weak economy, the dollar, interest rates and inflation are the lowest since 1970, says John Penson, a Texas A&M University ag economist.

The combination has bolstered everything from exports to farmland values. Sadly, that chapter might be drawing to a close. The reversal of these macro factors coincide with a drop in crop prices—potentially turning agriculture on its head, Penson explains.

A stronger U.S. economy that triggers a tightening of monetary policy and higher interest rates would not be bad news for all of agriculture. "If labor market conditions improve and incomes rise, the livestock industry could benefit from higher meat demand," Briggeman says.

Back to the Basics. While financial policy is important, everything still swings back to Economics 101: supply and demand, which ultimately drives this industry, Briggeman says. "Demand is more important than a several-point rise in interest rates," he says. However, the exception is farmers who have high debt-to-asset ratios.

It’s important not to get carried away. Macro factors such as those created by the Federal Reserve might sound ominous. "The takeaway for farmers is to focus on what you can control; know your break-evens and manage your balance sheet," Briggeman says. "Implement sound management and risk strategies."

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