There has been a lot of news this week about the Federal Reserve (Fed) raising interest rates. You may have even seen articles about how this affects each individual, whether it be the interest rate you pay on your mortgage or the interest rate you pay on your car loan. What hasn’t been reported on much are the affects an interest rate hike has on agriculture.
In general when we hear about the Fed raising interest rates we automatically think that all interest rates are going to rise. This is somewhat true but one must first understand what the Fed does and doesn’t control. The interest rate quoted by the Fed is the federal funds rate. This is the “rate at which depository institutions lend reserve balances to other depository institutions overnight,” according to the Fed’s webpage. Basically we can think of this as the interest rate that is used when one bank lends money to another bank. If this rate rises then the receiving bank will more than likely raise its prime interest rate, the basic rate at which that bank quotes for all of its loans. When prime interest rates go up then you can expect any variable rate loans you have to go up, such as a variable rate mortgage or a variable rate car loan. Some non-government student loans are also variable rate, so those should rise as well. On a positive note, money held in savings accounts should rise and those living off of the interest from savings accounts or money market accounts should benefit.
Rising interest rates affect agriculture in several ways. The most obvious would be any capital purchases that were made on variable rate loans. A 30 year variable rate loan on a farm purchase or a 5-7 year loan on capital improvements would likely see an uptick in rates. Likewise, low interest operating loans would also become more expensive as the Fed raises interest rates as the operating loan rate would increase.
What is not discussed much is how the federal funds rate plays into the strength of the US dollar and how that affects US agriculture. Historically when the Fed raises the target on the federal funds rate, we see an increase in the value of the dollar. While this is great for the consumer (i.e. more purchasing power), it generally translates in a decrease of commodity exports (becomes more expensive for foreign buyers as the foreign currency becomes weaker against the US dollar). The most recent two crop years, 2014 and 2015, have seen huge losses in the value of commodities. Some of this could already be attributed to a strengthening US dollar as well as a decrease in demand and an increase in overall supply of that commodity. The alternative is that domestic use/demand for commodities could rise as interest rates rise, sparked by the consumer having more purchasing power as the US dollar strengthens.
In reality no one can accurately predict how the Fed raising interest rates will affect US agriculture. Historically it has shown to reduce farm income. Only time will tell.
Here are a few articles/presentations for further reading:
Corn, Soybean Markets Absorb Fed’s Rate Hike (Agriculture.com 12-17-15)
Interest Rate Effects on the US Agricultural Sector With Emphasis at the Farm Level (Texas A&M University May 1997). An older article but its predictions proved correct as farmers did experience tough times during the late 1990s and early 2000s.
Extraordinary Monetary Policy Effects on Commodity Prices (University of Georgia 2015)
Agricultural Financial Outlook, Lending, and Land Values (Mississippi State University 2015)