Interest Rates On The Rise

Concerns about rising interest rates may be more psychological than financial.

“Interest rates have been so low for so long that, for a segment of producers, interest rates have been almost insignificant for their entire farming time frame,” says Farm Credit Services of America chief credit officer Tim Koch. “If we go back to the early part of this century or the 1990s, we were used to more fluctuation in interest rates, so it wasn’t as big a deal.”

The Federal Reserve has raised its federal funds rate .75% so far in 2018, with one more .25% increase expected in December. It’s part of steady, well-telegraphed plan to bring rates back to a neutral level--neither fueling or cooling the economy--after nearly a decade of rock-bottom rates.

On its own, Koch says higher rates won’t significantly increase the cost of farming. If a grower has a small $100,000 operating line of credit, for example, a .25% increase in interest rates raises the borrowing cost by $250.

COST CONTROL. But, on Tregg Cronin’s family farm, in Gettysburg, South Dakota, a higher interest rate is just one more cost he can’t control.

“Back of the envelope, looking at things, 2019 is going to be an even more expensive year than this one was,” he says. “We’ve been visiting about interest rates with everything. You could easily parlay that interest rate story into just about every other input.”

Fertilizer prices are up 10 to 15% from last year, seed costs are unlikely to decline amid several major mergers, and, since most generic chemicals are imported from China, Cronin expects tariffs will make them more expensive, too. Steel tariffs are also raising the price for all colors of equipment and making capital investments on things like grain bins more costly.

Koch says there’s another reason farmers will be paying more to farm in 2019. “Their suppliers now have higher interest costs. Those borrowing costs get passed along to the end consumer. There’s a long tail to the impacts of increasing interest rates.”

Cronin says producers of a commodity don’t have the luxury of passing on their higher costs of production. USDA expects farmers to earn $9.8 billion less in net farm income in 2018 compared to last year.

BANK ON BORROWING. With less cash coming in, more farmers are likely to rely on short-term operating loans to finance their increasing production costs. The average variable interest rate has climbed to nearly 6.25%, and bankers report repayment problems are beginning to arise.

Another side effect of the erosion of cash reserves: Demand for marketing assistance loans from USDA’s Commodity Credit Corp. (CCC) is the highest in a decade, despite higher interest payments and out-of-date rates. In 2017, farmers put 990 million bushels of corn under loan, just shy of the 1.07 billion under loan in 2008. Farmers often use marketing assistance loans as short-term financing to finance input purchases for the next growing season.

Cronin says the resurgence of CCC loans’ popularity illustrates how tough it’s getting in the farm economy, especially with national average loan rates of $1.95 per bushel on corn and $5 per bushel on soybeans.

“If those loan rates were actually reflective of what it costs to produce a crop, you’d have even more guys using them, because a lot of the time, USDA is the cheapest source of interest,” he says. In January 2018, USDA charged 2.625% interest on commodity loans. The rate for January 2019, if the Federal Reserve follows through with its plan for increases, would be 3.875%.

Cronin thinks more farmers will utilize marketing assistance loans in 2019 as commodity prices fail to keep up with the climbing costs of raising a crop.

“There are only so many things we have any control over,” he says. And, after years of whittling down expenses, “unfortunately, I think we’re getting to a point now where there just isn’t much left to cut.That’s going to be the troubling thing, I think, next year.”

Fed Factors:

> In 2018, the Federal Open Market Committee focused on increasing the federal funds rate in a steady, predictable way as the general economy strengthened. Most analysts expect one more increase of 25 basis points, or .25%, in December.

> The pace of rate hikes is expected to slow as the Fed monitors inflation, wage increases and other economic signals. It’s also reevaluating what it considers a neutral interest rate--a rate that neither fuels nor cools economic activity--as it works through the process of selling bonds purchased during the Great Recession. Two more rate hikes of 25 basis points are generally expected in 2019.

> The stock market and overall economy are performing well, but some say a recession is increasingly possible in the next few years. Raising rates now gives the Fed more options to spur the economy if and when a recession occurs.

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