Post COVID-19, runaway inflation has unsurprisingly caused a shift in the Federal Reserve’s monetary policy strategy, now expected to take a more aggressive approach to interest rate hikes. Both supply chain woes and an excess money supply caused inflation to rise 8.5% in March of 2022 compared to the same time in 2021. The crisis in Ukraine has sent commodity prices on an upward trend, furthering price hikes in the grocery stores and gas pumps. In an attempt to combat rising inflation concerns, the Federal Reserve began raising interest rates in March by .25% and is expected to deliver two more half-point rate hikes in the next few months, according to economists at Reuters. As a result, 30-year mortgage rates have peaked at over 5% for the first time in a decade. The current economic environment has some agriculturalists concerned with how rising interest rates could affect farmers’ balance sheets and borrowing capabilities in addition to the recent uptick in land values.
Rising Interest Rate Costs on Agricultural Debt
The most obvious impact of rising interest rates for farmers is a rising cost of debt; everything from operating lines to real estate notes. While yes, this is true, compared to historic levels, we are still experiencing a low-interest-rate environment.
Interest rate expenses as a percentage of total cash production expenses over the past few years have been quite low compared to historic levels. Total real estate and non-real estate interest expenses in 2020 were 5.3% of total cash expense, which is still much lower than the 110-year average of 9.5%. See the Figure below.
Experts at the University of Illinois suggest that if interest expense levels rise to the historical average it could put some pressure on farm income, however, strong commodity prices have the 2022 farm income expectations remaining strong. As for the farm sector, the US Farm Sector Balance Sheet stays solid with a forecasted Debt/Asset ratio of 14.11% for 2022. See the Figure below.
While this is an uptick from recent years, farmers are in a much better solvency position than they were in 1985 when the debt/asset ratio peaked at 22.19%. Those that lived through the 1980s farm crisis cite some similarities to current economic conditions, however, both farmers and lenders have become more sophisticated in their financial reporting and risk management strategies. As I noted in one of my recent posts, “The Bottom Line on Inflation”, this year more than ever is going to be important for farmers to protect themselves against inflationary pressure, which continues to put stress on the bottom line. More so, if strong commodity prices do not persist, farmers will need to start preparing adjustment strategies to ensure financial longevity; especially as expectations for 2023 input prices are on the rise. These strategies could include paying off more farm debt if 2022 farm income allows for it or locking in competitive input prices at an earlier date.
The U.S. Farm Sector Balance Sheet
Interest Rates and Agricultural Land Prices
The other impact rising interest rates could have is on agricultural land values. Within the last year, much of the Midwest has seen unprecedented price levels for farmland. The corn belt has experienced anywhere from a 20% to 30% increase in farmland values with little signs of slowing down. Farmland’s inflation hedging capabilities have caught the attention of institutional investors and farmers alike. Many people are wondering how long this uptick in prices will persist as the Federal Reserve continues to raise interest rates. The answer to this question is going to depend on a multitude of factors including how long will rising commodity prices persist and if inflation concerns will continue. It is something that farmers, appraisers, bankers, economists, and investors will be watching very closely as we begin the 2022 U.S. growing season.
Even though interest rates and overall costs are on the rise, the farm economy is still projecting strong returns in 2022. Strong commodity prices and land values are bolstering farm returns, but it will be more important than ever for farmers to adjust their risk management strategy and run analyses on how further rate hikes or price declines could affect their bottom line. Agriculturalists are optimistic about this growing season however, as we have seen before it just takes one unwelcome event to change the financial landscape. My advice is to continue watching monetary policy moves, the Russia/Ukraine conflict, and inflation expectations to safeguard your farm’s financial condition.
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