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Last week, the Federal Reserve hiked its interest rate by 0.75% in an effort to combat inflation. And while markets are expecting a similar rate hike in the not too distant future, this is a first step to decelerate inflation which is at its highest in the last 40 years.
According to Kevin McNew, Chief Economist at FBN®, the Fed will need to do more interest rate hikes in the next 6-12 months.
Join Dan English, General Manager of FBN® Finance and Kevin McNew as they discuss why the Federal Reserve decided to hike interest rates, what that means for farmers and how FBN can help alleviate some of the uncertainties of a fast changing economy.
Click on the chapter links within the video to jump to each section:
Why the Fed increased interest rates (00:10)
What farmers should focus on (04:39)
Why to consider Farmland Capital (05:24)
What’s happening in the energy market (08:05)
What it means for farmers (11:48)
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Dan English (00:00):
I'm Dan English. I'm the general manager of FBN® Finance. And I'm here today with FBN's Chief Economist Dr. Kevin McNew. Hi Kevin.
Kevin McNew (00:08):
Hey Dan, how are you doing?
Dan English (00:10):
Good. Well I think as a lot of people have seen now last week, the Federal Reserve hiked interest rates quite a bit.
And I think even a little bit more than what had been expected, maybe two or three weeks before that. Maybe could you just walk me through what the news was that prompted the Federal Reserve to raise rates and what that means?
Kevin McNew (00:32):
I think the Fed is realizing that they got a late start to this inflation issue. You know, a lot of us in the economic world have been saying for the last year that inflation is a problem and they're just now kind of getting their act together.
And they did need to raise interest rates a quarter of a point more than what was maybe expected, but absolutely it's needed.
We have inflation that is well over 8%, 8.6%, according to the last reading, which is at or above the highest rates we've seen in over 40 years. So the Fed has a lot of work to do. I don't think this is the end of the inflation or the interest rate hike story.
Markets are already kind of expecting another similar magnitude rate hike in the next meeting next month and probably another half a point gain before the end of the year. So yeah, we've got some interest rate movement company to curb this runaway inflation,
Dan English (01:33):
Do you think that the Fed is going to be acting like this is aggressive enough? Or do you think that they'll have to continually revise upward what they're doing to be able to combat inflation?
Kevin McNew (01:46):
Normally, the Fed is really trying to watch inflation, unemployment, the economy, and really in the last 30, 40 years, we haven't worried too much about inflation. And so having to watch inflation is a new issue. The Fed's going to have to deal with it.
And, and like I said, they got a late start to it, obviously because of the issues around COVID. And I think they're going to be laser focused on what inflation is doing as a result of raising interest rates. They don't wanna put the economy in a recession, but their number one priority right now is tamping down this inflation that is just really problematic for the economy going forward.
So I think it's all going to be about inflation readings as we get new data coming out. We're going to see some pull back and economic activity and surging prices. I personally don't think we're, we're going to be seeing something really quickly. That's going to change the Fed's outlook, which is they're going to need to do more rather than less in the next six to 12 months.
Dan English (02:54):
Do you expect that raising rates, dialing back their bond buying program, all, all the efforts that they're doing to have more restrictive monetary policy that's longer or your interest and higher, you know, baseline expectations for years to come?
Kevin McNew (03:18):
That's a tough one, Dan. I mean, because some of this is definitely, you know, policy related. I was a huge proponent of the Fed being more aggressive about interest rate hikes shortly you know, six months to a year after COVID because we did inject such fiscal stimulus into the economy and that's now having, you know, profound impacts.
But beyond that, we have what's going on in Eastern Europe, issues with energy prices and all these external exogenous forces that are really out of the Fed's hands. And so, they're trying to do this through a series of interest rate hikes and, and quantitative tightening to kind of throttle back the system, but, there's more action in the global market than the Fed can realistically control.
From your standpoint, as you kind of see and, and see what's going on in the agricultural lending space, I'd be curious if we're in this interest rate environment for the next two to three years, where should we be telling our farmers to focus on?
Should we be focusing on long term debt consolidation? You know, all those kinds of things about investment decisions become so important in this environment.
Dan English (04:39):
It depends a lot on the farmer's personal situation, their balance sheet. But one thing that we encouraged a lot of people to do and worked with a lot of farmers to do over the last year to two years, was to refinance at these lower rates before the most recent rate hikes.
For folks who have done that, they have a very different problem going forward, which is they have an amortizing loan that they're paying off every year where they have a very low rate. And how do they replace that? How do they cover the additional incremental costs as they, you know, either refinance that to take some cash out down the road or come in with higher and more expensive sources of debt.
Dan English (05:24):
One thing we're encouraging a lot of people to look at is we have a Farmland Capital program where we can take a second position and they can keep the first position in place.
At the low rate, we think that's going to be a great option for a lot of farmers. But more generally, I would say the risk of this going even higher still seems pretty significant to us.
And just the pace at which the rates have increased over the last six months has really been astounding. I think where folks can lock in rates for the next 10, 20, 30 years, and have some certainty that they're going to be able to remain profitable. We're encouraging folks to do that.
If rates come back down they can always prepay and refinance at a lower rate, but where they can lock in longer term, we think that's definitely the right thing now.
Kevin McNew (06:13):
As I think back long term, I've been farming all my life and in the ‘80s as a farm kid, I remember the interconnectedness of coming of the ‘70s, roaring with bull markets.
The ‘80s brought hyperinflation and land values going through the roof. And then in the early ‘80s was a big farm depression. I know there's many gray-haired farmers out there that have the kind of experience that have seen these kinds of ebbs and flows.
What I've been telling them as it relates to farmland is I don't think we have a huge downturn in farmland values, and we don't see a huge recession or depression even in commodity prices, because it's a much different story today than it was in the ‘80s where we had oversupply issues. This is not that situation. We don't have an oversupply issue.
We have an over demand issue and commodity prices may back down a little bit but I think farmland values don't tank and bottom out or, or turn south quite sharply. If there's ways to capture more farmland as they fall down, or in your case you mentioned the Farmland Capital situation, that's a really intriguing concept.
Dan English (07:31):
I think for farmers who are looking who may be concerned about that, that's a way for them to take a little bit of risk off the table while still being able to have upside control and ownership of their farm.
One thing that we're paying very close attention to on the financing side is will farmers be able to support their farm at these, you know, lower prices? Maybe you can just talk a little bit about what the forward curve of green prices are doing. And it sounds like you think some of these prices are here to stay for at least a little while.
Kevin McNew (08:05):
They're definitely catching up as we get more permanency around the demand side of the story. A lot depends on energy markets and I don't think the energy situation is going to improve dramatically.
Obviously, a lot depends on the situation in Eastern Europe. Overall we're in a much different energy paradigm.We're trying to make this global transition from fossil fuel based energy to clean energy. And that's not a simple, easy solution. It's going to involve a lot of volatility. And I think this is just the start of what will be at least another decade of volatility in the energy markets, which in my opinion means more benefits for agriculture as we are linked in the biofuel space.
For 15 years we've been linked with ethanol but now there's such a big push around renewable diesel and that translates into demand for soybeans, for example. So I don't see a ton of downside risk, as I said, it's not to say we won't have ups and downs. But the forward curves are starting to look better and catch up. I do think the days of $3 corn and $8 beans are probably pretty far behind us until something dramatically shifts either in the energy sector or other other places. But there's just so much pin up demand if you will.
Dan English (09:33):
That's great news for our farmers. And one thing that I know a lot of people see as one of the drivers of energy is the war in Ukraine and the resulting markets. It sounds like even if that were resolved tomorrow, we're talking about more fundamental issues than the short term issues..
Kevin McNew (10:00):
Economists will call it a knife edge solution as we try to transition from fossil fuels to clean energy. A knife edge is really razor thin. And so a nice, smooth transition is very hard to achieve because there's so much imbalance.
Just to give you some perspective, since COVID, we have seen a downgrade in refining capacity in the U.S. and that's not out of coincidence. That's because the big oil companies are recognizing either internally or from pressure from outside investors that they have to shift to clean energy.
We're still a society that's heavily dependent on fossil fuels, but the supply of those fossil fuels, whether from crude oil, from refined products, is dwindling because of this pivot. And so, again, it's not an easy solution. I do think you're right. If we did get Russia and Ukraine to resolve for some reason, there'd be a pullback. But I don't think we're done with the days of a hundred dollars crude and $4 or $5 gasoline and diesel you know, for any time period.
Dan English (11:22):
Well, that's good news for our farmers.
Last question I have for you. Is there anything that you know, could fundamentally alter the inflation picture in the U.S., aside from what the Fed is proposing to do, or is this going to be something that's kind of hard fought, there's going to be rate increases and it's the situation we're in?
Kevin McNew (11:48):
This is going to have a pullback in investment and all of the investment things that are driven, whether it's real estate, especially home values. But for our farms, I think we're so tied to food, which has an exceptionally highly elastic demand.
That means it doesn't respond much to prices. People have to eat is the main take home message. I think from our farm sector standpoint you know, what would change the paradigm substantially is if energy markets collapsed.
It's hard to see a scenario where that happens. If we go back to the last big energy market downturn of 2007 or 2008, we went from $140 barrel oil quickly down to $40 and $50 barrel oil.
That was really because we saw China on this meteoric rise as a global economy and we needed a throttle price where we could pull back demand.
Until we start to see real signs of demand and pull back, it's hard to see where inflation starts to get tamed. Not saying it won't happen but the numbers I watch and the things I see, we're just not seeing the demand pull back and in the commodity space, I think that's really true.
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