An Urban's Rural View

Is it time for farmers to fret about interest rates?

In one respect it's always time. As seed, fuel and fertilizer prices have risen, farmers have relied more than ever on borrowing to finance operations. Like the cost of those inputs, the cost of money needs to be managed.

On the other hand, the Federal Reserve has kept interest rates super-low for more than five years and has predicted they'll stay low another year or two. There's every reason to believe Janet Yellen, the Fed's new chair, is as committed to that prediction as her predecessor, Ben Bernanke. And the statement the Fed issued March 19 after its latest monetary-policy meeting seemed to indicate the central bank was staying the course.

Yet the bond market's immediate reaction to the Fed's statement was to send short-term rates higher. The dollar strengthened, another sign that rates could be headed north. Clearly someone out there thinks the Fed will start tightening sooner rather than later.

To be sure, the Fed statement continued the "taper," reducing extraordinary bond purchases another $10 billion a month to $55 billion. That's another move toward a less stimulatory policy. But it was widely expected and should have been priced in to market rates.

At the Fed's current pace the taper won't end until later this year, and at her first press conference as Fed chair Yellen indicated the Fed would wait at least six months from the end of the taper before raising rates. That suggests low rates through spring 2015.

Of course, the Fed could change its mind should the economy boom and inflation surge. If investors smell an inflation problem before the Fed does the bond market will sell off, boosting rates whether the Fed likes it or not.

But the economy is far from booming and inflation looks tame. For the last two months the consumer price index has risen at a 1.1% annual rate, well below the Fed's 2% target. Many economists still fear deflation more than inflation.

Writing in the Financial Times (http://tiny.cc/…), Philip Hildebrand, vice chairman of the investment firm BlackRock, detects an early warning sign of inflation in a recent trend of richer wage increases. In late 2012 they were running at a 50-year low of 1.3%. Now the growth rate is up to 2.5%.

That's a sign, Hildebrand argues, that the economy is "closer to its potential level than previously thought. If so, the time to begin tightening monetary policy might come sooner than currently projected."

It's true that wage inflation has been known to spook central bankers as well as bond markets, and with good reason: It can mark the beginning of the most dangerous kind of inflation, the wage-price spiral.

But as Hildebrand concedes, wage growth at 2.5% falls well short of the 3.5% rate before the financial crisis. And the Fed under Yellen may be prepared to let inflation edge a bit above the 2% target if unemployment remains high.

So the bond market may be reading the Fed or the economy wrong; it's happened before. If it turns out the market has done it again, the rise in short-term bond interest rates that followed the Fed statement won't continue.

Even if the bond market was right to be surprised by the Fed statement, rates may stay very low awhile longer. Futures had suggested investors expected a Fed move higher in the second half of 2015, not the first. The suggestion that higher rates could be coming a few months sooner, in the first half of 2015, could account for the market's reaction.

First half or second, neither the market nor the Fed is looking at significantly higher rates this year. With luck, then, farmers can put off fretting about interest rates for another few months.

Urban Lehner

urbanity@hotmail.com

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