In March, during one of its eight scheduled meetings in 2016, the Federal Open Market Committee (FOMC) announced it will hold the current Federal Funds rate of 0.25-0.50 percent. This comes three months after the December announcement of the Federal Funds rate increase near zero percent. By leaving the rate unchanged, the FOMC brought policymakers’ projections into alignment with investor and economist expectations and strengthened the ability to follow through with future rate increases.
In FOMC material accompanying the March announcement, policymakers’ expectations of 2016 rate increase frequency dropped from four increases to just two. This closely aligns with what the Wall Street Journal Survey of Economists and futures markets had been predicting for several months. When the FOMC increased rates in December 2015 and policymakers’ expectations averaged four rate increases in the upcoming year, market and economist predictions already assumed two increases in 2016. The March announcement brings FOMC projections into alignment with widely held expectations.
The FOMC’s decision to keep rates unchanged eases the pressure on the dollar, the strength of which has been a drag to the U.S. economic recovery. Even with near record low yields on U.S. Treasury securities, these rates are attractive to investors compared to even lower rates in most developed countries. When the Bank of Japan moved to negative rates to combat deflation and the European Central Bank went deeper into negative territory, the U.S. became more attractive to investors. Since global demand for U.S. Treasury securities requires the purchase of U.S. dollars using foreign currency, this increases the strength of the dollar.
Steady rates signal future increases
Holding rates steady for now makes future rate increases even more plausible. The decision to increase rates is driven by many factors, one of which is recent market performance and how those markets may respond to rate changes. If markets continue to perform well, the likelihood of a “Yellen call” increases. This newly coined term represents the potential of future market increases influencing the likelihood of policy action being taken to increase rates. All else being equal, the equity markets tend to be negatively impacted by higher interest rates, thus the “call,” which implies a ceiling on returns. Holding rates steady now strengthens markets across the board, which in turn makes the economic environment more conducive to additional rate increases.
In a recent survey, The Wall Street Journal Survey of Economists indicated that 60 percent of those surveyed predicted an additional .25 percent increase in June 2016. Additionally, the March announcement has significantly lowered rate expectations for 2017 as the FOMC has made it clear that while more rate increases are coming, they will be gradual. As stated in the press release accompanying the announcement, “The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”
What does this mean for agriculture?
In short – what does this mean for the agriculture industry? After coming off a historic decade of low interest rates, the impact will be felt more by operators with higher debt levels, particularly short-term debt. While the rate increases are expected to be gradual, the effect on earnings already under pressure from low commodity prices will be more impactful than during the peak of the ag cycle. The most immediate impact farmers may see is in short-term rates for credit like operating loans, so operations should take care to plan cash flow.
Now is still an ideal time to take advantage of current lull rates. Farm operations should double their consideration of refinancing long-term loans and converting variable-rate loans to fixed rates before future increases – rates will not be this low forever.
Many current Farm Credit customers have already taken advantage of Farm Credit’s loan conversion program. A conversion fee of $350 allows farmers to lock in today’s low rates on any size loan. There is no need to gamble on interest rates. FOMC has given every indication that rates will continue to rise gradually, so converting a variable-rate loan to a fixed rate today can give farmers peace of mind for the future.
Farm Credit is committed to being a reliable source of capital for customers in any economy. We advise them to always make borrowing and buying decisions based on opportunities and business need.
For additional commentary and perspective on trends affecting ag finance download the Farm Credit Mid-America Insights Report.