Inflation-Induced Interest Rate Hikes Poised to Hit Farmers Hard

 

In response to rising inflation, the Fed has indicated that “it will soon be appropriate to raise the target range for the federal-funds rate” (Wall Street Journal, Fed Tees Up March Interest-Rate Increase, January 26, 2022). As will be discussed, farmers (to some degree) typically have a built-in inflation advantage that salaried and hourly workers can only dream of—namely, income that is responsive to inflation in real time. However, interest rate hikes like those on the imminent horizon can offset or even erase those advantages. If you haven’t protected the gains you’ve made and prepared for the risks ahead, you may face a situation no one wants—increased farm and household costs on top of a declining income.

 

Is Inflation Really That Bad?

 

Before we dig into the combined impact of inflation and rising interest rates on farm income, it’s fair to ask how concerned we should be about inflation in general.

The last time we experienced today’s 7% inflation was in June of 1982 on the tail end of the rampant and painful inflation of the 70s. Triggered by the OPEC oil crisis, inflation had become ingrained in the economy over years and was only tamed by harsh monetary policy and the resulting economic contraction.

Since then, inflation has retreated to becoming a rather benign part of the business cycle, mildly flowing as the economy heated up, and contracting as the economy corrected. Take, for instance, the two biggest inflation spikes topping around 6%: the economic correction of 1991 halved the inflation from the end of 1990, while the 2008 correction saw an actual reduction in real prices, as inflation went into the negative category.

What, then, can we make of the inflationary surge triggered by COVID? Is this akin to a more typical business cycle where we can expect inflation to retreat rather meekly? Or more like a shock to our economy a la the OPEC oil crisis with a deep and lasting impact?

 

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Unfortunately, our inflation rate at 7% has already broken past what we typically have experienced since the OPEC oil crisis, and the Fed appears to be ready to address the risks of structural inflation through government intervention. Regardless of whether you believe our inflation issue is transitory or structural, the question for farmers is how badly your income will be affected and for how long. That’s because the remedy for reducing inflation is raising interest rates, which has a direct offsetting effect on commodity prices and, ultimately, farm income.

 

Corn Prices and Inflation Tend to Track on a Relative Basis

 

By definition, rising inflation rates mean that consumers must spend more for purchases of everyday goods and services. As a part of the underlying inflation calculation, it makes sense intuitively that prices for farm commodities (including energy goods) track with inflationary pressures overall.

Take corn prices vs. inflation in the chart shown below. Since 1980, corn prices have tended to peak and contract in parallel with inflation in spite of absolute shifts ahead or behind each other. For instance, corn prices leaped ahead of inflation in 2006 on the heels of the ethanol mandate and again in 2012 as a result of the drought. Nonetheless, prices followed a similar pattern to inflation over that same timeframe. For farmers, that means that as inflation has ebbed and flowed over time, income has mostly kept pace on a relative basis.

Importantly, note that corn prices began consistently outpacing inflation around 2005. At this point, farm income began outpacing inflation, which meant an increasingly large share in your pockets over time. Although many factors are at play—such as the price of the dollar relative to other currencies—interest rates can have a powerful impact on commodity prices.

More specifically, as interest rates rise, the price of the dollar rises as more investors seek interest-bearing investments and turn from non-interest bearing investments like commodities. At the same time, purchasers of commodities turn to sources outside the U.S. as it is cheaper to buy those commodities from countries with weaker currencies. Depending on how high the interest rate rises, all of this spells a potentially steep decline for U.S. farm income. This also potentially ends the relative advantage farmers have held over inflation throughout the past decade and a half.

 

The Technicals Suggest a Potential Range of 3.25 to 6.1% for 10-Year Treasury Notes

 

When the Fed takes action, what can we expect? The interest rate on the 10-year Treasury notes has been in a downtrending channel for about 25 years (as shown on the next page in the purple band). The technicals (specifically, the inverted head and shoulders formation shown in the orange circle) suggest a possible move to a Treasury note priced at about 3.25%, correlating closely with a retest of the 2018 high. Also, if rates do break out to the upside through the upper channel line and over the 2018 high, the move would project to a target of about 6%, which is the depth of the channel (3.6%) and the upper end of the market (at about 2.5% this month) combined.

Recent history suggests these estimates are reasonable. In 2014 and 2018, interest rates had reached peaks of about 3% and 3.25% respectively with much less inflation. Specifically, in 2014, the rate of inflation was around 2% and, in 2018, 3%. With today’s current rate of inflation at 7%, it’s not difficult to believe that 10-year Treasury rates could go back and re-test the 2018 highs of 3.25%.

 

What are the Implications for You?

 

Given current inflation and upcoming interest rate movements by the Fed, the conditions exist for an upcoming negative impact on commodity prices that can affect your income both relatively and absolutely in relation to inflation. This means the relative gains that you have made over the past couple of years have the potential to be upended.

You have the potential to adopt strategies to help you managed the risk associated with inflation and rising interest rates. Talk with your consultant at TFM360 to make sure you are prepared when the time is right. You can feel confident that we are continually monitoring the fundamentals and charts and are fully prepared to incorporate them into our recommendations. We will keep you informed as events unfold, and look forward to helping you make the right decisions for your operation.

Go to www.totalfarmmarketing.com or call us at 800.334.9779

to make a difference in your farm marketing.

 

©January 2022. Past performance is not necessarily indicative of future results. Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Total Farm Marketing and TFM refer to Stewart-Peterson Group Inc., Stewart-Peterson Inc., and SP Risk Services LLC. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of National Futures Association. Stewart-Peterson Inc. is a publishing company. SP Risk Services, LLC is an insurance agency and an equal opportunity provider. SP Risk Services LLC and Stewart-Peterson Inc. are wholly owned by Stewart-Peterson Group Inc. A customer may have relationships with all three companies. TFM360 is a service of Stewart-Peterson Group Inc., Stewart-Peterson Inc., and SP Risk Services LLC. TFM360 consultants are provided by Stewart-Peterson Group Inc.