Glacier FarmMedia – Canada’s largest agricultural lender says Canadian farmers can expect to see interest rate relief in the coming year.
In a macroeconomic snapshot released in December, Farm Credit Canada said it expects to see rate cuts totalling 75 basis points (three quarters of a percent) in the latter half of 2024.
That’s despite recent strong economic performance in the U.S., which would ordinarily cause heightened inflation concerns, says Krishen Rangasamy, manager of FCC Economics.
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“The U.S. economy did well in the third quarter (of 2023) but decelerated quite a bit in the fourth quarter,” he says. “What we see here is the U.S. Fed saying ‘we have raised rates enough we think. They’re at 5.5 per cent now, and we’re already seeing interest rates have done their job.’”
Those signals were amplified Dec. 13, about a week after the FCC report was issued, when the U.S. Federal Reserve declined to raise rates and forecast at least three reductions through 2024, Rangasamy said.
Key to these moves is the U.S. Federal Reserve’s inflation forecast, he added, noting it also included good news in the form of a downgraded inflation forecast.
“That’s super-important,” Rangasamy says. “That’s what’s been bothering them for a long time. Now, for the first time in a long while, we see them downgrading their inflation forecast.”
The U.S. central bank’s view that inflation will continue to fall extends as far as the end of 2025, at which time it expects to see inflation at or near the ‘sweet spot’ target of two per cent. At that level, the economy comfortably avoids the perils of deflation, but also furnishes businesses and individuals with predictable prices for goods and services.
On the curve
For more insight into the interest rate winds, Rangasamy says the yield curve, as it is known, reveals a lot about the bond market’s expectations on interest rates.
In simple terms the yield curve is comprised of the interest rates paid on government bonds of varying terms, from short to long.
At the near end of the curve, defined as zero to 12 months, rates are higher right now. That represents the efforts of centrals bankers around the world to increase interest rates to dampen inflation to acceptable levels.
At the far end of the curve, represented by 10-year bonds, the rates are lower. That represents the views of market participants that the U.S. Federal Reserve will inevitably have to lower interest rates.
The curve now runs downward over the entire span of the chart, which is counter to its usual state, and is known as inversion, Rangasamy says.
“In normal times, the yield curve should be upward-sloping. It’s been inverted for more than a year now.”
The unusual shape of the bond yield curve is like a graphic representation of the battle between central bankers and the market forces of the economy.
Too soon?
The role of central bankers is as much art as science, as there are many unpredictable variables that can affect economic outcomes. For example, who saw COVID coming?
That means there could be risk that central bankers are taking their foot off the brakes too soon. And hitting the gas — in the form of lower interest rates — might reignite inflation.
But here Rangasamy says markets are signalling conditions loud and clear. Ten-year U.S. Treasury bonds were yielding five per cent on Oct. 15. On Dec. 14, the day he spoke to Glacier FarmMedia, they were 100 basis points, or one full per cent lower.
“We’ve seen a huge rally in bonds, and bonds and interest rates move inversely to each other,” he said. “If you bought that bond two months ago, you’ve done very well.”
That’s happened because rate hikes have brought inflation down, and down markets are pricing in the expectation that central bankers will have to lower rates as the economic effects are felt, and growth slows and steadies.
“Economic theory tells us that when we have slow growth, inflation will fade away,” Rangasamy says. “It gives confidence that the downtrend in inflation will continue.”
Weathered well
While nobody running a business welcomes the prospect of higher borrowing rates, Canadian farmers have been well-positioned to weather the storm, especially when compared to other stakeholders like homeowners with variable-rate mortgages.
That’s been apparent in buoyant land values and healthy farm equipment sales, both of which have continued throughout the spike in both inflation and interest rates.
“Higher rates, of course, make life harder, because borrowing costs are higher,” Rangasamy says. “But farm cash receipts were good in both 2022 and 2023, which explains why we are seeing this resilience.”
The next challenge for farmers will be managing their interest rate risk during this unusual time. With long term interest rates lower than short term ones, a fixed term rate might be more attractive than it normally is, for example.
“At the long end of the yield curve — five and 10 years — the Bank of Canada and Federal Reserve can’t control rates, and it’s actually going down,” Rangasamy says. “But the Bank of Canada has said it’s not ready to cut, so the short end is stagnant while the long end is going down.”
That makes the old question of fixed or variable rates a whole new query. Over time, variable rates might still be a better deal for borrowers than fixed rates, but it’s not the shoe-in it has been historically.
It will come down to the individual borrower, their financial position and their tolerance for risk balanced against their desire for financial certainty.
For this reason, Rangasamy doesn’t advise farmers to go it alone. Interest rates and the yield curve and how it can change aren’t straightforward, and the right choice depends on many variables.
Asked what advice he’d give farmers, Rangasamy urged them to cast a wide net to gather wisdom leading up to the decision.
“Farmers should be speaking to their financial advisors,” he says. “It’s a very complex subject.”
