How the Federal Reserve Will Affect Your Farm in 2018

Last week, the Federal Reserve made an important announcement.

After eight years of historic stimulus efforts, it is bringing its Quantitative Easing (QE) program to an end.

You might have heard about this on CNBC or on the radio.

Then, perhaps you asked… “What does it mean for the future?”

Some people on Wall Street are panicking and saying that we’re going to have another financial crisis. Others were surprised to find out that the Fed was actually still providing stimulus to the economy.

But what matters is how this is going to affect farming operations and grain prices in the future.

Here’s what you need to know.

Yes, This Decision Was Big

The Fed’s decision to “unwind” its stimulus program is one of the most important economic decisions of the last decade.

Following the 2007-2009 financial crisis, the U.S. central bank bought bonds, mortgage-backed securities, and other assets in an effort to bolster the American economy. Literally, to the tune of a couple Trillion dollards. Literally.

As thousand of Billions of dollars.

By making these purchases, the central bank aimed to prevent deflation, bolster the U.S. employment, and stabilize the economy.

While the success and failures of this program have been debated by economists, one thing is clear.

It sure cost a lot of money.

The central bank built its balance sheet from $1 trillion to $4.5 trillion since it began quantitative easing.

Now, the Fed will “wind down” this balance sheet.

This will be a gradual process, but it will remove liquidity – or capital – from the market, meaning that money that markets expected to be there won’t anymore.

Some think it could cause the markets to panic. Others – like myself – are giving the Fed some leeway because there are too many factors at play.

There has never been a balance sheet this large. But there has also never been an unwinding like this one with such a technologically advanced, global, and liquid market. So, any people who can say with “certainty” that a major economic event is going to happen as a result is either lying to Americans or lying to themselves.

Now, this is a lot of information.

But I just wanted to give you a bit of background before I got into the important matter: How it impacts your farming operations and your bottom line.

Impact on Rates and Farm Prices

The Federal Reserve has raised interest rates three times over the last year. But last week’s announcement did not include any clues into the timing of another interest rate hike.

The markets are split down the middle on whether or not the central bank will hike rates again this year, according to CME Group’s FedWatch Tool. But we are at a point where interest rates are rising after about 30 years of declines.

As we’ve explained in the past, rising interest rates offer a boost to the U.S. Dollar. Since grain prices are in U.S. dollars, a stronger dollar only dampens demand for U.S. exports.

But the unwinding process will have a similar economic impact to what happens when the bank raises interest rates. The unwinding process will reduce the expectation of new capital into the system. The decision to begin this unwinding has pushed the dollar to two-month highs, but more gains are in store over time.

How much?

The Financial Times said in March that unwinding process would be similar to the impact of two interest rate hikes of 25 basis points (a total of half a percentage point.) [1]

Overall, let’s just say the range is between 40 basis points to 60 basis points (in non-financial-speak, that’s 0.4% to 0.6%). That isn’t anything to sneeze at. As a result, the 10-year interest rate could rise to around 3% in 2018. The question is whether the longer-term rates will rise more substantially.

The question posed is how this plan is going to affect farmland prices.

Rising interest rates are always negative pressures on farmland prices for two reasons. Higher rates increase financing costs and increase debt, and they make farmland a little less attractive as an investment compared to alternative assets.

But when it comes to the Fed’s “winding down” gambit, things are still very early. In conversations with various economists over the last two days, the consensus is that the impact will be… not much.

The process of “normalizing” interest rates is going to be a slow process. Some have described the Fed’s plan similar to watching “paint dry.”

I would argue that this event is the great unknown. And any panic right now is just “noise.” The concerns are if the longer-term rates get away from the central bank and begin to affect the capitalized value of farmland. That means the price of cash rent divided by the 10-Year Yield. [2]

I’ll dig more into this in the coming weeks…

As I said, it’s supposed to be like watching paint dry, so we will have time.

Right now, there is plenty of liquidity in the real estate markets, and credit quality remains positive for farm purchases, refinancing, and other loans.

Sure, credit quality isn’t as good as it was a few years ago when grain prices were higher, but the overall expectation is that the unwinding process is going to be such a long process that there won’t be any immediate downturn or negative event that should raise concerns.

It could be a bumpy ride in the broader markets, but the Fed has been warning about its plans for more than a year.

With increased signaling to the market and clear communication, the central bank wants to avoid the “taper tantrum” that occurred in 2013 and sent shockwaves through the bond markets.

We’re going to have to ride this out for a little while. But we’ll be weighing interest rate and Fed balance sheet risks in all of our insight into grain prices as the harvest progresses.

About the Author
Garrett Baldwin

Garrett Baldwin is a content strategist and editor at FarmLead. He covers the global grain markets and public policy issues related to the agricultural industry. He is a graduate of the Medill School of Journalism at Northwestern University. He also holds a Master’s Degree in Economic Policy from The Johns Hopkins University, an MS in Agricultural Economics from Purdue University, and an MBA in Finance from Indiana University.

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