Higher Ag Loan Interest Rates: A Sneaky Impact of Tariffs and Policy Uncertainty?

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Key insights:

  • Trade disputes with major agricultural export countries are likely to result in lower-than-projected farm incomes and, consequently, an increase in demand for short-run loans and higher likelihood of loan defaults. 
  • Both increased demand and higher default rates will place upward pressure on interest rates charged for agricultural loans. 
  • Uncertainty about tariff implementation and trade dispute consequences shifts investors’ demands from stocks to Treasury bonds, decreasing bond yields.
  • Bond yield decreases can place additional pressure to short- and medium-term loan interest rates, exacerbating the adverse impacts on farm incomes. 

If you drive around the U.S. farm country this summer and ask what the most concerning is for the agricultural community, the most likely answers will be: weather (okay, that’s every summer) and trade. One would be hard pressed to find a member of the U.S. agricultural community who isn’t waiting with bated breath to discover the new twist in the international trade dispute drama.

Short-run impacts of both enacted policies and uncertainty about future actions are already being seen and felt by farmers. For example, at one point today (June 20, 2018), soybean prices fell to their lowest point (in nominal terms) since March 2, 2009. Longer-term consequences of retaliatory tariffs by China are being researched by agricultural economists all over the United States, with current projections painting a rather bleak picture of lower prices and production (i.e, lower revenues).

However, one aspect that has not been considered is the potential effects of the disputes on interest rates and overall interest costs encumbered by farmers. Let’s first consider two avenues through which interest rates are likely to rise, especially if trade policy and its uncertainty continues on their current paths. One path is through increased demand for agricultural loans.

If current market conditions persist and projections about short- and medium-term decreases in farm revenues transpire, it’s not unlikely that there would be an uptick in both the quantity and amounts of operational loans. This is especially the case because the U.S. agricultural sector has observed several consecutive years of lower or flat net farm incomes, which has placed pressure on farms’ short-run liquidity and access to cash.  Concurrently, lower prices and decreased revenues could also result in higher default rates on existing loans. This, too, can result in agricultural lending institutions increasing collateral and interest requirements for new loans as a means to reduce their exposure to default risk.

A second, perhaps less obvious avenue through which interest rates can increase is the flocking of investors from a more uncertain and volatile stock market and into the bond market. The possibility of even larger tariffs and simply the uncertainty about the impacts of continued trade disputes on global markets has already prompted investors to pull funds out of stocks and place them into a lower-risk investment, government bonds. As short-term U.S. Treasury bond yields decrease (as a result of higher investment), their interest rates grow. Typically, financial institutions closely follow these trends and adjust their interest rates accordingly. These adjustments could place additional pressures and exacerbate the interest rate increases that agricultural businesses face.

Why do higher interest rates matter? They represent additional farm business costs. Consider the classic profit equation: Profit = Revenues – Costs. The lower market prices and studies (described above) that show lower production are primarily showing downward pressures on the Revenue part of the profit equation. That’s bad enough. But the increased interest rates and higher interest expenditures represent higher accounting (current) and opportunity (future) costs, which could occur concurrently with the decreasing revenues. This could especially spell trouble for farm businesses who have variable interest rate loans, which were taken out during a period of relative interest rate stability.

While I am fully aware that a post like this is a great example of why Thomas Carlyle called economics a “dismal science,” I’ll close on two positive notes. First, many farm households own both farm (e.g., land) and non-farm assets (e.g., retirement investments) that would appreciate in value as a result of rising interest rates. Second, within a broader time perspective, interest rates are still at historically-low levels.

(Photo by kenteegardin is licensed under CC BY 4.0)

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About Author

Dr. Anton Bekkerman is an associate professor in the Department of Agricultural Economics and Economics at Montana State University, joining the faculty in 2009 after completing his PhD at North Carolina State University. Bekkerman's primary areas of research are grain marketing, basis and price forecast modeling, understanding how grain prices are affected by changes in supply chain infrastructures and quality demands, and analyzing the economic trade-offs of adopting alternative dryland cropping systems in Montana. One of his current projects is an investigation of how new grain loading technologies are affecting prices that Montana farmers receive for their wheat. Bekkerman is also examining the economic impacts that Montana's rapidly expanding dry pulse industry will have on the state's crop industry. Although Bekkerman grew up on the east coast, he has recently made a small step toward production agricultural after acquiring three backyard chickens.

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