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Future of interest rates getting lost in haze of election season

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Money cheaper than this year’s corn or dollars scarcer than frost in July? Political speeches may remind farmers of a weathervane in a tornado this year, and all the fancy quips boil down to this: Things are going to change.

With the 2016 presidential election just a few days from completion, those in the agriculture industry have wryly noted that their issues are at the heart of the debates, even if neither candidate has addressed them as such. Gun rights, health care, and rural infrastructure all fall under this ag umbrella. Key among these issues is that of the Federal Reserve System and its decisions concerning key interest rates. And while detailed discussions of interest rates don’t generate as much as interest as easier to understand topics, to those whose income relies on farm lending and heavy equipment purchases, they’re fertile ground for discourse. Whatever comes out of November’s election, farmers need to consider what the Fed rates mean to their bottom line.

At some point, experts agree that the bubble will burst unless rates inch up gradually, but just how gradually and when this starts is presently anyone’s guess.

Throughout the Republican primary races and up through October, GOP candidate Donald Trump has repeatedly accused the Federal Reserve and its current chair, Janet Yellen, of political motivations in maintaining historically low interest rates in an effort to maintain an artificially inflated economy to bolster Democratic President Barack Obama’s administration. And while his Democratic rival, former Secretary of State Hillary Clinton, quickly and continuously denounced his statements as a politicization of what is supposed to be a non-partisan process, her endorsements of banking reform suggest that under her administration, rates are likely to rise as well. The Federal Reserve board voted again to retain the historically low rates, with a target range for Fed funds at 0.25 percent to 0.5 percent, meaning the U.S. prime rate remains at 3.5 percent. Another vote by the Federal Reserve board will occur Nov. 2, at which point a rate increase could occur. But observers across the world agree that the protectionist ideas espoused by both candidates concerning the Trans-Pacific Partnership and other foreign agreements could cause a softening in the economy, if not out-right trade wars, leading the Federal Reserve to further suppress rates in an effort to keep the markets afloat. This despite all signs point to a coming rate hike.

Confused yet?

If so, don’t feel lonely. The Pew Research Center and other national surveying groups routinely report that the American public has little, if any, knowledge of what the Federal Reserve system is and how it affects banking policy, interest rates, and money supply. Couple this with the most dizzying partisan rhetoric in the history of modern politics, and farmers trying to figure out future moves are left quite perplexed.

Scenario 1: Rates go up

Chicago Fed President Charles Evans said in late October he expects three quarter-point increases between now and the end of 2017.
Farmers who borrow money would do well to perk up at that announcement. Since 1949, the U.S. prime rate has ranged from 2 percent to 20.5 percent with an average of 6.7 percent. The present rate of 3.5 percent has been in place since December of 2008 when the Federal Reserve slashed it to help stave off the ill effects of the market freefall underway. Farmers using operating loans through banks or credit unions would see interest rates begin to trend upward, meaning their ability to finance future crops will be diminished. Furthering the concern, historical trends suggest that increased interest rates push down commodity and other crop prices even though, in the long-term, they should soften the dollar a bit and make exports easier to sell. Still, further depressed prices on top of more expensive financing doesn’t sound too appetizing to the U.S. agricultural producer. Also, as interest rates on mortgage vehicles rise, the ability of buyers to purchase land diminishes, and this has a negative impact on land values.

Scenario 2: Rates stay low

Regardless of the election outcome, farmers should be aware that at this point, the only reason the Federal Reserve would vote to maintain low rates is because the economy remains too weak to handle an increase, or if a protectionist-driven trade fight breaks out between the U.S. and its partners, further weakening exports. Also, a rate increase is likely to be unpopular across many zones and whether one agrees with Republican Donald Trump or not on other issues, many do agree that political appeasement has been a factor in suppressing hikes in the past. But if Greek and Puerto Rico debt issues continue to worsen, or European Union moves such as this year’s Brexit head in a more protectionist, anti-trade direction, then long-term interest rates could be suppressed as foreign investors seek the safety net that is U.S. Treasury bonds.

In this scenario, both interest rates and commodity prices would likely remain on what experts agree is a bubble. Federal Reserve Bank of Kansas City President Esther George warns that continued rate suppression could lead to major problems down the road.

“Postponing the removal of accommodations when the economy is near full employment and inflation is rising toward the 2-percent target rate could promote alternative risks that would decrease the likelihood of achieving our long-run objectives,” she said earlier in 2016, explaining the cheap money can lead to overvalued land and other assets.

What to do?

At some point, experts agree that the bubble will burst unless rates inch up gradually, but just how gradually and when this starts is presently anyone’s guess. Just how bad this will be depends on whose predictions one reads. But for farmers needing to plan next year’s financing or asset purchases, the best advice would be to talk to lenders now and if possible, lock in the lowest rates while still available.

 

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