Audio Transcript

Brady Brewer: Hi and welcome to the Purdue Commercial AgCast, the Purdue University Center for Commercial Agriculture Podcast, featuring farm management news and information. I’m Brady Brewer, an associate professor of agricultural economics. And joining me today is Michael Langemeier, professor of agricultural economics here at Purdue, and the associate director for the Center for Commercial Agriculture. On today’s episode, we will be covering interest rates in the agricultural sector and also talking a little bit about the agricultural credit markets.

So, I want to lead off here, Michael, and, you know, think about where interest rates are going. So, the first item I want to discuss is the averaged fix. So, this is the 30-year fixed farm real estate interest rate, and it has been declining here over the past decade. But we’ve really seen a pretty steep decline in it, you know, starting around the 2020 area.

1:05

But it has recently started to increase. So, the data that I pulled is from the Federal Reserve. So, a lot of the Federal Reserve banks across the nation do ag credit surveys, but the two that I pulled are the Kansas City and the Chicago Federal Reserve data. So, the latest data we have is from the quarter one. So, January, February and March of 2022, they won’t release the quarter two until about August.

So, the Kansas City Federal Reserve, the 30-year fixed rate was at 4.78%. And then the Chicago Federal Reserve District, the average fixed mortgage real estate for farm real estate was right up 4.4%. So pretty low, you know, still showing pretty low interest rates.

1:57

Michael Langemeier: Yeah, certainly. And even when you compared to 2019 before COVID, we were looking at interest rates 5.25 to 5.5. And so, we’re quite a bit lower than what we were prior to COVID. And so and so these interest rates that we’ve seen the last two or three years, we thought those were going to be temporary. I mean, obviously, there’s some other pressures besides COVID getting a little better that is causing interest rates to come up.

But even, you know, even if they would come up 1%, yeah, they’re probably going go up more than that. But if they go up 1%, we’d still only back where we were in 2019.

Brady Brewer: Yeah. So, we’re not even talking about, you know, highs of a decade. We haven’t even reached a high of the past four years. Now, as I said, this is quarter one. If you know, I fully expect once we get the quarter two data in later this year, you know, that those may be in the 5% range, somewhere in the 5% range they’re going to be – We will talk about the federal funds rate here in just a little bit. It has obviously come up. So, we expect these to fully come up from where they are in this data. 

3:00

Michael Langemeier: Yeah, one of the things that’s always interesting when you talk to younger people, they don’t necessarily remember some of the higher interest rate days. But one of the things I’ve done here with some of this data, some of this data from the Federal Reserve back to Chicago, for example, is I looked at the ten-year averages starting in 2007, you know, starting with the ethanol boom.

When you looked at ten-year average, it started in 2007, you were up at 7.5%.  And so that just tells you how low we are today compared to us were even in 2007, which isn’t that long ago, they’ve done nothing but decline. Those ten-year averages are all the way to 21. Now we’re going up the other way and we’ll see how we’ll see how we get close to those 2007 rates or not.

But now we’re kind of going the other way. And so, my point is here, there’s some people that have never really seen anything but, you know, fairly low interest rates. And so, this will be a shock to some people as they start to adjust upward.

3:55

Brady Brewer: Yeah, and definitely we’ll need to include that on cash flow projections. You know, thinking about the operating loans and other loans you may be getting here over the next year. Now, I want to compare this to, you know, maybe what we’re seeing outside of the farm sector and if you look at non-farm fixed, so it’s essentially the equivalent to the farm mortgage. So, a 30-year fixed mortgage for non-farm real estate. So, you think about this, this is the interest rate that most people get when we go get a house a house loan for the quarter one 2022, it was at 3.82%. So, it is lower right now than the farm real estate. But it’s actually seen a much steeper increase here in 2022 than what the farm real estate interest rate saw.

And I attribute that, Michael, and maybe you think a little bit differently than me, but I attribute that to an increase of risk in the non-farm credit markets.

Michael Langemeier: I think that makes a lot of sense. I mean if you compare our interest rates in agriculture to the prime interest rate, for example, the margin is not that big compared to what it has historically. Historically, if you’re comparing the operating loan to the operating interest rate in agriculture to the prime interest rate for the top borrowers, is the way the Fed is defined. The Federal government defines that that number. You typically looking at 1.5%. Right now, we’re looking at 1%. And so, what that tells me is agriculture is not very risky. If you look at the financials or maybe from University of Minnesota, FINBIN or other sources of data, solvency remains very strong, very low, below solvency, at least on average for the most part.

And farm and liquidity are much better than last year in particular because 21 was a good net farm income year. And so yes, I do think there’s that right now there’s not as much risk in agriculture as there probably is in the housing market.

5:47

Brady Brewer: Yeah, so not as much risk, you know. So, I am also part of a survey with colleagues here at Purdue and Kansas State and we ask ag lenders around the nation about very similar to the Federal Reserve survey. But we ask, you know, what’s happening to non-performing loans in your loan portfolio. And you know, say, Michael, a lot of the lenders that write in the comments I put no change on delinquency, but that’s because we don’t have delinquent farmers in our loan portfolio.

So, a lot of liquidity out there and a lot of, you know, the risk factor on the ag side in the ag credit markets is just so much less than in the other credit markets for lending or other sectors of the economy. You know, so the non-farm real estate is going up. I do expect it to continue to go up. There are reports I’ve seen some news articles recently for, you know, on the auto loan side, a huge increase in repossessions. I’ve also seen some data that has shown that we’ve seen a pretty big spike in delinquency of net 30 days past due on credit cards here in the U.S. So, we’re starting to see a lot more risk factors show up in what I’m going to call leading indicators of the economy.

And that’s going to continue to drive up that risk component. When banks price interest rates, it’s you know, they got to charge you what it costs them to get the funds, which is the Fed funds rate or, you know, there’s some other ways and get funds like checkable deposits, but then they also have to price in the risk component as well. And we’re seeing that in the farm mortgage rates.

So, the other thing that I want to talk about or the other interest rate I want to talk about when it comes to farm is, you know, so we’ve talked about the land, the real estate, but let’s talk about the operating or, you know, intermediate loans as well. So, if we look at the intermediate interest rates for Q1 of 2022 for both the Chicago and Kansas City Fed, they’re, you know, operating is always higher than real estate because they’re always a little bit riskier.

So, the Kansas City Federal Reserve District was at 5.21% and the Chicago Federal Reserve District was at 4.6% for operating loans given in in Q1 of 2022.

8:00

Michael Langemeier: Yeah, as I was indicating, the prime rate was about a percentage below the Chicago rate there. Actually, was about 1.2 percentage below that. So, the prime rate was about 3.3% in the first quarter. Now, obviously, these rates are going up. We’re going to talk about Fed funds rate here a little bit lower while we’re talking about operating interest rates here, how much how much upward pressure is there?

You know, if you look at the Fed funds rate, it seems to me when you’re comparing to quarter one, there could be at least two percentage, but every two and a half percentage points possible increase in that. What does that mean for the for the operating interest rates Brady?

Brady Brewer: Obviously extreme upward pressure. I mean, let’s just we all know that’s happening. I think the question that you’re getting at, Michael, is, is how much upward pressure is there? So, if there currently a 5.21% in Kansas City, 4.6 in Chicago, you know, again, this is Q1 data. We know that we’re already through Q2 now, and into Q3. We know that the Q2 data is going to come back at least half a percentage point higher, maybe even 75 basis points or 100 basis points or a full percentage point higher than what we saw in Q1.

So, we’re already probably seeing, you know, five and a half upwards for some of these numbers. Once we get the Q2 data back, we know that the Fed funds rate, you know, the next FOMC meetings here at the end of July. And we’re going to get to some of the inflation numbers, the recent consumer price index numbers that just came out here in July continued to increase.

You know, if you’re thinking operating loans, Michael, I think that by the end of 2022, you know, when farmers go to renew their production loans for the 2023 growing season here in the Midwest, you could see two, two and a half percentage higher than what we’re currently seeing. That that means that puts us in the seven and a half percent range.

10:05

Michael Langemeier: Which would be, again, I’m looking at some historical numbers here, which would put us back about where we were in 2007-2008.

Brady Brewer: Yes.

Michael Langemeier: So, it’s been a while.

So, it’s been a while. Yeah.

Brady Brewer: Yeah, that’s 15 years.

Michael Langemeier: That’s, that’s been a while.

Brady Brewer: So, for, for the operating note, it could be the highest operating note interest rate for the last 15 years.

Michael Langemeier: And we’re going talk about inflation and I’ll bet you start thinking about man at seven half percent. Why is it why so high? Well, think about where inflation is right now. I mean, the interest rate, by definition, the long term, the interest rate has to be higher than inflation, you know, because, you know, we want a positive real rate there.

And so that’s one of the things that’s going on here is inflation was at 2% for a long period of time, 10-15 years. If you look at the look at the average inflation rate, it was at 2%. We’re not in that territory right now, nor will we be anytime soon.

Brady Brewer

Yeah, and let’s Michael, just talk about inflation really quick, because I think that’s a big determine of where these interest rates are going. And we spoke about this in our podcast last month, but the Bureau of Labor Statistics just released the June 2022 CPI numbers, and it was up it was in the 8% range, and we are now above 9% inflation.

So again, I just want to remind everyone, you know, so the June 2022 inflation that BLS just reported was 9.1%. So, the interpretation of that 9.1% is, so they have a basket of goods that they look at. That basket of goods in June of 2022 prices are 9.1% higher than that same basket of goods in June of 2021. So, it’s a year over year inflationary measure.

11:40

Michael Langemeier: And with that level of inflation and you see this in the headlines all the time, that that’s what kind of way they refer to these numbers. It’s been 40 years. It’s been 40 years since we’ve seen inflation that high. And you go back 20 years, you know, 5-6% was high. And now we’re way above anything we’ve seen in the last 20 years.

Brady Brewer: I do want to point out, though, is that there have been some economists and Michael, I was actually talking with our colleague Jim Mintert, a couple of weeks ago about this. And there are some economists that are arguing that the inflation, this 9.1% is high. It’s not as high as what we saw in the 1980s. What they’re arguing, though, is that we’re actually above where we are in the eighties. Their argument is that how we measure the CPI index is, as you know, the wallet shares of how we spend our money is as a consumer has shifted, and we don’t adjust for that shifting. We essentially, you know, to boil down the argument, to simplify it, is that we now spend a lot more on real assets like housing and real estate. And we don’t necessarily adjust for that share of wallet.

And if you do, they do the calculations and they actually show that inflation is just as bad as the 1980s right now, currently. So, you know, with the current way, you know, I don’t want to get too far down that rabbit hole, Michael, right now of how we measure the inflation. It’s increasing, it’s the worse it’s been in, you know, over 15 years.

Not as bad with these current measures the 1980s but you know I think the question for me is I was kind of expecting it to level off here, start to level off and it’s still going up. So how high do we think the inflation could go here by the end of 2022?

13:33

Michael Langemeier: Yeah. I keep reading that. It’s going to it’s going to taper off here a little bit. When we hit 9% here in June, it would be it would be hard to believe it dropping to as low as 6% any time soon yet alone, you know, dropping further than that. And, you know, we have to go back to the Fed does have a goal of 2% inflation and people read that 2% differently.

Some people think that’s a cap. Others think, well, that’s kind of a long run average rule.

Regardless of if you think that’s a cap or a long run average, we’re way above that and it’s going to be a long time. And even the Fed admits that it’s going to be a long time begore we get this driven down to where their goal is.

Another thing I wanted to say, why we’re talking about inflation. We know we’re talking to a lot of businesses in this podcast. You know, businesses know that this is measuring consumer prices. Wholesale prices have also been very high. In fact, I’ve seen some double digits for some of the recent months on wholesale prices. Also, agriculture. If you look at USDA all items paid coming from national agriculture, says Tesco service going from May 21 to May 22, that’s up 17%. And so yes, consumer prices are up substantially. Well, we have to remember also obviously, wholesale prices and the prices that businesses are paying for inputs is up substantially too.

And the reason I mention that is that that’s going to continue to put pressure on consumer prices. I mean, obviously, businesses can’t continue to absorb these high prices. They pay for inputs and not pass at least some of that on to the consumer. Yeah.

15:13

Brady Brewer

Yeah, and when you, you know, thinking about the wholesale prices, when you break down the CPI into different categories that, you know. So, from June 2022 to June 2021, the basket of goods that represent all energy items. So, this is gasoline, diesel, oil, electricity, propane is over 40% higher than what we were spending on these energy goods back in June of 2021.

That’s just remarkable to me. And then energy is a large part of that wholesale inflation in agriculture.

Michael Langemeier: If you look at just diesel, for example, let’s continue this a little bit. Again, this is using USDA data. This is coming from the Agriculture Marketing Service. They do some surveys in Illinois and Iowa looking at input prices for various items, fertilizer and fuel. It’s up 75%. And obviously we’ve seen some weakness in fuel prices recently. But nevertheless, we’re still at much higher levels than what we saw even a year ago.

Brady Brewer: Yep. So, Michael, I next want to turn so, you know, inflation is a big part of where interest rates are going. And the other part is the cost of funds, which is can really be represented here by the Fed funds rate. So, for those that don’t follow, we talked about this on our last interest rate episode that we did a month ago.

But the Fed or the FOMC, the Federal Open Market Committee, has met since we last did that in June, and they released their new dot plot, and they also raised the Fed funds rate by 75 basis points. Okay. So, a couple of things I want to mention here is that this was actually a deviation from plan. The FOMC committee is the, you know, the board of governors of the Federal Reserve, and they have some other people that’s on that.

They had really set a course in the spring where they were saying, we’re not going to raise more than 50 basis points of time. And then one month later, they raise it 75 basis points. So, they already deviated from their plan. And that was in large part because of the inflation numbers that they got in June, which were higher than expected.

And then the other thing I want to point out here is that normally they the Fed, tries to be this beacon of stability and they try to say, here’s what we expect to do over the next six months. Huge deviation. The Fed actually said, we’re not going to say what we’re going to do because we’re going to let the data guide us, and we don’t want people making decisions on what they think we’re going to do and then we deviate from the course.

You know, we were talking before we started recording, Michael, of what the Fed, you know, this next meeting is going to do. I actually think with these increase numbers, you know, when they released this, I did some quick calculations say, okay, based on the dot plot they just released, they’re going to have to raise interest rate about 50 basis points in 2022 for each of the next four FOMC meetings to reach this target of 3.4% by the end of 2022 for the Fed funds rate.

I think with the new inflation numbers, we may see another 75-basis point increase. Now, it’s not guaranteed, but it’s I’m sure it’s something that they’re going to discuss.

18:15

Michael Langemeier: Yes. And if you look longer term, Brady, they are they are thinking that the Fed funds rate would not necessarily stay at these elevated levels long term. You know, they’re thinking the Fed funds rate would gravitate back to about 2.5. However, I would like to point out that they’re also assuming that inflation is going to go back to 2%.

Now, that’s long term. Even they realize that inflation is going to be, you know, two and a half, 3%. I think that’s rosy scenario, but that’s what they’re currently their current thought process is for 23 and 24 is inflation at two and a half to 3%. And so, what I’m saying is that two and a half percent reduction in the Fed funds rate going into 23, 24 and longer term assumes that inflation is going to come down.

And so that’s the key thing to look at when you’re thinking about interest rates is what what’s happening to inflation? Is it coming down from these high levels we’re seeing now? And more importantly, is it coming down closer to that long term goal of 2%?

19:17

Brady Brewer: Yeah, and we know it’s going to come down, but I don’t think we’re going to get to that 2%. Yeah, I.

Michael Langemeier: Yeah, I just think it’s going to be tough to get to that 2% anytime soon.

Brady Brewer: So, what I’ll point out here on this dot plot is, you know, the dot plot is a representation of the median expectations for each of the FOMC committee members. So, we’re seeing the median, we don’t know the true range of what their expectations are there. The high range that they could be expecting could be all the way up to 5 to 6%.

Okay. Will that probably happen? No, that’s why they’re showing us the median, because that’s the most likely. You know, there’s a couple of the FOMC committee members that think that by the end of 2022, we could see the Fed funds rate all the way up to 4%. Right. So that’s you know, that’s a 75-basis point increase over the next 2 to 3 meetings, not just the next one.

So, you know, there are some scenarios in there where we could see a pretty high increases of the Fed funds rate.

20:14

Michael Langemeier: But again, factoring in what we’ve been talking about here with the Fed funds rate, I’ll just throw some numbers out. And I think these what would be consistent of what you talked about earlier, 7% for real estate loans, seven and a half percent for operating. If they have to be more aggressive, those rates would be even higher than that.

Brady Brewer: Yeah, I completely agree there. You know, and that’s just through the end of 2022.

Michael Langemeier: Yeah, there’s usually about a half percent or so difference between the operating in the real estate. We’ll see if that continues down the road.

Brady Brewer: And a large component of that is the risks that we’re seeing in the ag credit market. So, let’s turn our attention to that risk component of the interest rate. So, we can pull the U.S. bank call report data. And again, this data is through the quarter one of 2022. So, January, February and March. This data ends in March of 2022.

And if we look at the farm real estate delinquency rates and this is the number of farm loans out there that are past due date, so in some type of delinquency. So, this is past net 30 days due, past net 60 days due.  And also, those that may be in amortization or collections. We’ve actually seen this from the quarter one of 2021, We’ve seen a pretty sharp decline in the delinquency rates for farm real estate loans. You know, again, we talked about the increased liquidity out there in the farm credit markets, the increased profitability, you know, due to various factors. The long term, if you look at like the 30, 40-year average here, Michael, farm delinquency rates have traditionally been about 2.2, 2.3%, depending on what time period you’re going. So, when we were at the peak in 2021 when we were starting to see an increase in farm delinquency on real estate loans, we were just to that 30–40-year average and where we have down pretty sharply from that long run average, this is a pretty good sign of the risk that’s out there. Or in other words, decreasing risk.

22:29

Michael Langemeier: And even with the lower crop prices we’ve seen recently, looking at the fall of 22 and the fall of 23, when I when I kind of crunched some very tentative budgets for 23, for example, things still don’t look as bad as what they were from 14 to 19, which was a bit of a hiccup in production agriculture. We saw some declines in land values during that time period.

And so that’s a good signal. Now, as we continue these podcasts, we’ll update people on that fact. But I don’t expect these delinquency rates to spike anytime soon. I think we’re going to stay relatively low because of the financial situation we’re currently in. And the good cash flow in 21 is going to last a while.

I think that’s really helped give some liquidity back into the agriculture sector. And 22 even though like I said, the prices are lower 22 is not going to be a bad year depending on yields. Now there is some weather risk out there in spades, in some parts of the country. But, you know, assuming that those wrinkles can be ironed out, things don’t look too bad for 22.

23:36

Brady Brewer: Yeah. You know, so thinking about the delinquencies, a leading indicator that I like to look out for farm loan delinquencies is loan renewals and extension. So, what a loan renewal and extension is, is let’s say you’re a farmer goes to his banker, and they don’t have enough money to pay the operating note from a current crop season. If that farmer has adequate equity, they can amortize it, they can collateralize it, they can put it into a long-term note. They can do an A/B note. There’s a lot of options that a banker has to work with a farmer that may not be able to repay the full amount of their operating note.

So, both the Kansas City and the Chicago Federal Reserve in their Ag Credit surveys that they send to their bankers and in their loan service territories, they ask, you know, are you do you see an increasing number of these types of situations or a decreasing number of these types of situations?

And what we see is that bankers, by and large, say, no, I’m doing this less and less. Which that’s a pretty good sign. You know, delinquencies are kind of a lagging indicator. You see that on the back end when things go bad in the ag credit markets. This is this is as I said, a leading indicator because a banker is going to do this before a farmer, you know, gets to that delinquent portion before a bank says, no, we can’t do anything for you. You need to pay or else.

Now, we saw a pretty sharp, you know, decline in these instances in 2020/2021. We do see a fairly flattening off, but it’s not increasing it. We don’t bankers aren’t saying, yes, we are increasing these types of situations with farmers in our loan service territory. So that’s a pretty good sign.

25:21

Michael Langemeier: Yeah. And looking ahead, you’re probably going to see some increases in some parts of the country because 22 is not as good a year as 21. And you know, so as you we get to the end of 22 and into 23, you probably can see some increases there. But again, I don’t expect some very large spikes.

There’s nothing on the you know, on the horizon when you start looking at the net farm income forecasts that would necessarily indicate that there’s going to be a large spike in these and delinquencies, for example.

Brady Brewer: So, putting this all together, Michael, when we think about where interest rates are headed, I mean, you know, I think the easy assumption here say interest rates are on the rise. We now know that. The question is, where are they headed? We’re still below 2019 level. So, it’s not a doomsday scenario yet, but it is you know, I would advise all farmers, you need to be thinking about your cash flow budgets for, you know, next crop year when you’re going to get your operating note this fall, there’s going to be an increase in interest rates. That seven, seven and a half percent range is where, you know, I would expect it unless we start to get some inflation numbers that are just really here through the Q3 of 2022. That’s kind of the range I would expect interest rates to be in.

Michael Langemeier: I one of the things that you want to note here, we talked we alluded to it earlier is real interest rates are very low right now. In fact, if you look at the difference between the nominal real estate rate and the Federal Reserve Bank of Chicago, and you look at the inflation last year using the PC in place of price deflator, you had a real interest rate that was below 0.5%.

Now that’s historically low. You know, if you look from 73 all the way to today, that the real interest rates like 3%. If you started in 2007 at the beginning, the ethanol boom is still close to 2%. And so, the reason I bring that up is the 7% for real estate loans and the seven and a half percent for operating loans, they’re really building in those inflation expectations. For that to happen, inflation is going to have to probably come down about 5% or so. And that’s the signal again, if you don’t see inflation coming down closer to that 5%, you’re probably looking for even more upward pressure on those, both real estate rate and the operating rate.

27:34

Brady Brewer: The other point I want to make here, Michael, is that, you know, if you look at some of the farm credit data, you know, the majority of farm real estate loans are on fixed interest rates. Right? So, these interest rate increase that we’re talking about is not going to impact any loans that are currently made. You know, and I would say that given the currently historically low interest rates that we have seen over the past decade, I would say most you know, I don’t have the data on this. That 75% number I have is about 10-12 years old. I would say well over 80-85% of the farm real estate loans are probably in a fixed basis.

So, this isn’t going to be a huge hit to the cash flow for, you know, for loans that are already made. So that’s a good thing.
The other thing, biggest impact will be to operating or intermediate loans, since those may pose the highest risk if we do see a deterioration of liquidity in the credit markets.

28:30

Michael Langemeier: Yeah. And the real estate loans are primarily fixed or if not exclusively fixed in most cases. And so, we’re looking at new real estate loans. But even in that situation, again, you’re looking at the nominal real estate loan compared to inflation and that real interest rate is really low right now.

And so I don’t think these increases, we’d be talking about interest rates, is going to have a large impact on the land value, same as famous last words there, and particularly given the high inflation, because we have to remember when we’re looking at land values, land is a good hedge against inflation and so even inflation remains above 5% in particular, the interest rates we’re talking about here you’re just not going to have that much influence in the land market.

It’s going to be more associated with cash flow. Just nonfarm investor demand has been really hot right now. Does that stay that way? Likely. And so, there’s some other factors are probably more important than the interest rates we’re talking about when you’re looking at land markets.

29:29

Brady Brewer: Yeah, I would add on to that, is that real assets, you know, people typically say that real assets are the hedge for inflation. So that means that you could actually see some increased attention to the farm real estate markets from outside investors using real estate as a hedge for a high inflationary period in the general economy.

Michael Langemeier: Yeah, I usually think gold, silver and farmland. And real estate in general, but we all know you talked about it earlier. There is some there is some risk considerations when you’re looking at some of the real estate, when you talk about the housing market. But the economy, if the economy goes into recession here, just real estate and, you know, urban real estate for commercial businesses is also going to face some risk.

Brady Brewer: Yep. The next FOMC meeting, they will meet July 26th and 27th of 2022. So, coming up here, you know, so we will see what the Federal Reserve does. You know, we got a few more FOMC meetings here through the end of 2022. And I think it’s going to be interesting. You know, I said earlier that we could see another 75-basis point increase to the Fed funds rate.

I don’t know if that’s guaranteed. You know, I think for sure it’s going to be 50 basis points. But it’ll be interesting to see what the Federal Open Market Committee does here moving forward based on these new inflationary numbers.

So, with that, that’s a wrap for our discussion today on interest rates. You can find more information at the Purdue Center for Commercial Ag website, which is purdue.edu/commercialag.

I encourage you to share the podcast with your friends and colleagues. On behalf of Michael Langemeier and the Purdue University Center for Commercial Ag. I’m Brady Brewer and I thank you for listening.