This past year has certainly been a huge challenge for the agricultural economy. Issues related to COVID-19, extreme volatility in commodity markets, processing issues, labor shortages, labor costs, and trade were just a handful of challenges agriculture faced in 2020.
Government support certainly helped mitigate some of the impact of these issues and was a big positive for farm receipts during the year. Federal farm program payments paid directly to farmers and ranchers are forecast by the United States Department of Agriculture at $37.2 billion in 2020. This is a $14.7 billion increase (66%) over 2019.
Federal farm program payments are always a great “shot in the arm” for farmers, but support payments can run hot and cold depending on a plethora of variables, starting with who sits in the White House and the make-up of congressional leadership. This past year was certainly “hot” from a payments standpoint.
As we kick off this year, we also realize 2021 may be on the “cold” side when considering those same variables. While the government support payments were great, I believe the best thing to come out of 2020 for agriculture was low interest rates. The impact of low rates was significant in 2020, will be even more significant in 2021, and the overall impact will be long lasting.
As the COVID-19 pandemic took hold in March 2020, the Federal Open Market Committee (FOMC) reduced the Federal Funds Target Rate (Fed Funds Rate) 1.50%. At the same time, they began purchasing large amounts of short-term and long-term U.S. Treasury securities and mortgage-backed securities.
The Federal Reserve has increased their holding of these securities by nearly $3 trillion in the last year. The goal of the FOMC was to keep financial markets liquid and to reduce short-term and long-term interest rates to help our struggling economy.
While short-term rates like Fed Funds Rate, the Prime Rate and Libor all declined approximately 1.50%, the 10-year U.S. Treasury rate has also fallen approximately 1% in the last year and remains near historical lows.
The FOMC appears committed to maintaining these low rates for at least the near future. On Aug. 27, 2020, Federal Reserve Chair Jerome Powell announced changes to the FOMC’s long run targets of inflation and monetary policy strategy. Powell specifically announced a change in the committee’s targeted inflation goal.
The FOMC now “will aim to achieve inflation moderately above 2.0% for some time,” indicating they will allow inflation to exceed their 2% target if the inflation rate had been averaging below 2% for a period.
While the FOMC is still maintaining their long-term inflation target of 2%, the move signaled that the FOMC will prioritize the achievement of full employment over preventing inflation from rising above 2% in a given period. This suggests the FOMC will likely keep interest rates near 0% for longer than was previously anticipated to provide accommodative monetary policy and support for the economic recovery.
So, what does this decrease mean to farmers? The USDA has forecast that interest expense for farmers declined $5.6 billion in 2020 compared to 2019. Those interest savings should be even more in 2021 as the lower rates should be effective for the entire year. The average Farm Credit customer in the United States is paying 1.07% less on their borrowings compared to last year.
The average GreenStone customer is paying nearly 1.2% less on their debt than one year ago. For a borrower with a $500,000 loan, that’s an average annual savings of $6,000. If the farmer is borrowing $1 million, the interest savings is $12,000. I used to have a boss that liked to say, “Pretty soon you are talking real money!”
I think we’re there!
The Fed Funds Rate can be raised whenever the FOMC wants to, but they are certainly strongly hinting that they will keep rates low for a long period of time. At the same time, historically low long-term rates are allowing large purchases for farmers to be more affordable, and maybe just as important, allowing them to refinance or convert their current long-term debt to a lower rate. This allows borrowers to “lock-in” in these low rates for years to come.
Low long-term rates are also a major support for equipment prices and especially land prices as these assets are made more affordable. I have read that some economists estimate the value of an acre of land based on land rent divided by the long-term discount rate.
The theory basically is if a farmer can rent their acre of land for $200 per acre and the discount rate is 5%, then the land is worth $4,000. In the last year, long-term rates have fallen 1% or more. Under the economic model from above, the acre of land may now be worth $5,000 per acre.
I understand that valuing land isn’t that easy. The “value” may be much different if you are the seller or the buyer; and many times, it may also depend on how many neighbors have their eye on the same piece of property or if a nearby dairy is looking to expand their land base. But low rates certainly bring outside investors into the bidding and make their purchase and rent models much easier to reach when debt costs are lower.
I have a habit of saying that certain things are “magic.” Magic allows our company to reach more than one goal or measure. Well, low interest rates are certainly “magic” for our customers. Low interest rates have the immediate impact of lowering their operating costs and improving cash flows. But locking in low long-term rates keeps that cash flow benefit for future years and supports strong land and equipment values.
Now the bad news. I am often wrong with my economic predictions. I tell anyone who asks my opinion to just do the opposite of what I do, and they will be very successful when they invest. But here’s hoping that interest rates stay low and the “magic” continues!
*As originally published in Michigan Farm News on January 15, 2021.
