An Urban's Rural View

With its dramatic half-point interest rate cut, the Federal Reserve has acknowledged something farmers and ranchers have been only too aware of: Interest rates are too high given current economic conditions. Barring an unexpected resurgence of inflation, the Fed is signaling they're going to come down, probably a lot.

The question is, how fast -- and for farmers and ranchers, how soon they'll start to benefit from lower rates. As DTN Farm Business Editor Katie Dehlinger noted in her story on the half-point cut, it takes time for changes in the Fed's benchmark Federal Funds rate to filter through to the economy. (https://www.dtnpf.com/…)

From the spring of 2022 through the summer of 2023, the Fed raised its benchmark federal funds interest rate from near zero to well over 5%, the highest level in more than 20 years, and left it there. The five percentage point-plus increase was the biggest in 40 years.

The Fed had to move hard and fast because inflation was raging -- prices at one point were rising 9%. Meanwhile, the job market was strong, with two openings for every job seeker.

Today's economy looks very different. Inflation has come down to near the Fed's 2%-a-year target. The job market, though still healthy, has been progressively softening, as the time-lagged effects of earlier rate increases kick in. The economy is barely creating 100,000 new jobs a month. August's 4.2% unemployment rate is well above January's 3.7%.

In this economy, a Federal Funds rate above 5% represents extremely tight monetary policy. No one, including the Fed, knows for sure the "neutral" rate of interest -- the level that causes neither inflation nor unemployment. Everyone agrees it's well below today's rate. Markets are putting it at just below 3%.

In their most recent economic projections, released Sept. 18, the Fed officials who make the interest rate decisions appeared to be confirming the market's expectations. The officials' median Sept. 18 forecast is for the Fed Funds rate to end this year at 4.4%, next year at 3.4% and 2026 and 2027 at 2.9%. (https://www.federalreserve.gov/…)

Does the half-point cut mean the Fed sees a recession on the horizon, as some analysts have suggested? Not necessarily. At his post-meeting press conference, Federal Reserve Chair Jerome Powell said the economy is "fine." He said the labor market is "in solid condition" -- and the Fed intends to keep it there. (https://www.federalreserve.gov/…)

In other words, having been behind the curve in fighting inflation, the Fed is positioning itself ahead of the curve in fending off a recession. It still hopes to achieve a "soft landing" for the economy.

What lies ahead is a series of further rate cuts. The pace of the cuts -- whether they'll be quarter-point, half-point or even bigger -- is something Powell said the Fed will decide meeting to meeting. It will depend on the economic data. A continuation of worsening unemployment, for example, would hasten the pace.

On the ground, the rates borrowers pay and savers earn don't necessarily move in lockstep with the Fed's benchmark rate. They'll generally track the Federal Funds rate directionally but they may not move as much or as fast.

Different rates behave differently. For example, even as the Fed moved rates higher over the last few years, many banks were stingy about paying more on savings accounts. On the other hand, home-mortgage rates have already come down in recent weeks in anticipation of the Fed cutting. The average 30-year fixed mortgage rate was a tick above 7% in late May. On Sept. 19, it was a tick above 6%. (https://fred.stlouisfed.org/…)

Sometimes the time lags in the workings of monetary policy are at the discretion of borrowers. With the drop in mortgage rates, homes have become more affordable for would-be buyers and many homeowners could profitably refinance their mortgages. Yet refinancings haven't taken off and home sales actually fell 2.5% in August. Borrowers and potential borrowers are holding off because they rightly expect rates to decline still further.

What farmers will pay in interest for operating loans next year will depend in part on how fast the Fed moves. It will also depend in part on how quickly banks move in following the Fed's lead. A complicating third factor for some farmers could be their credit ratings. The losses some have recently experienced will naturally make them riskier borrowers in their bankers' eyes.

But if the Fed factor weighs heaviest, farm operating loans next year should be at a lower interest rate than this year's, and lower still in 2026.

Urban Lehner can be reached at urbanize@gmail.com

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