The Federal Reserve Open Market Committee (FOMC) of the Federal Reserve (Fed) met March 15-16 and voted to increase the Fed Funds Rate by 0.25%. This move was anticipated by the markets following public appearances by Fed officials in late February stating their inclination to increase rates at the meeting. This article will address how this will impact farmland and export prices through a series of domino effects.
For the first time since rates began rising in December 2015, the vote was not unanimous. Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, voted to leave the rate unchanged. The FOMC cited moderately rising household spending, slightly improved business investment, and steady job growth as the primary drivers of current economic conditions. Because the rate increase was highly anticipated by the markets, the impact was minimal. The prime rate immediately increased to 4.00%, effective March 16.
The Fed voted to continue re-investing maturing Treasury securities, agency debt, and agency mortgage-backed securities. An ongoing buyer in the bond market, the Fed is continuing to be accommodative with its monetary policy. The market will watch with keen interest to see when the Fed will begin to reduce its balance sheet by either changing its re-investing policy, or by selling some of its holdings. The Fed’s balance sheet totals more than $4.4 trillion compared to approximately $800 billion in assets 10 years ago, as seen in Table 1. It consists of approximately $2.4 trillion of Treasury securities, $1.7 trillion of mortgage-backed securities (primarily Freddie Mac and Fannie Mae issued), and $300 billion of assorted assets. The sale of the mortgage-backed securities and/or the Treasury securities would likely mean an increase in interest rates as new buyers would need to be enticed to buy these bonds.
The next Fed meeting is May 2-3. The futures market currently projects a less than 5% chance of a rate hike at this meeting, although it predicts a 46% chance of another 0.25% rate hike at the June FOMC meeting. Fed officials have been openly advancing the idea that the most likely scenario by year-end includes two additional rate hikes, with the possibility of an additional third, with each hike being 0.25%.
Ancillary Impacts of Higher Interest Rates
Higher interest rates traditionally have several domino effects, many of which impact the agriculture industry. For example, returns to farmland have loosely correlated to the yield on the 10-year United States Treasury (UST) over time. If long-term rates move higher and net returns to land do not follow, land prices have a tendency to trend lower to adjust the return to correlate to alternative investments (such as the 10-year UST). For more information on this subject, read a farmdoc daily article from Dec. 20, 2016 by Gary Schnitkey of the Department of Agricultural and Consumer Economics at the University of Illinois at Urbana-Champaign.
Higher interest rates have typically meant a stronger dollar versus other currencies, making U.S. export products more expensive to foreign customers. If carryover stocks of major U.S. commodities remain on the rise due to a combination of strong production and weaker export demand, crop prices and farm incomes would continue to be under pressure. If you haven’t explored locking in interest rates on long-term debt, it may be time to consider your options as the FOMC sends strong signals to the market indicating the era of ultra-low interest rates has come to an end.