Top 10 Ag Stories of 2023: No. 2 - Interest Rates on Farm Loans Soar to 20-Year Highs as Fed Fights Inflation

MT. JULIET, Tenn. (DTN) -- The Federal Reserve's medicine for feverish inflation appears to be working. Inflation declined to 3.1% in November, much closer to the Fed's 2% target. Unemployment rates didn't flinch. The Fed appears poised for a soft landing.

But it's rarely that simple, Rabobank cross-asset strategist Christian Lawrence said. There's usually some form of collateral damage. "It's like shooting a mosquito with a shotgun."

The Federal Reserve changed its mosquito hunting strategy midway through 2023.

At first, it kept with 2022's aggressive schedule and raised rates four times. By the time of its last increase in July, the federal funds rate was in a range of 5.25% to 5.5%, the highest level in 22 years.

By midsummer, recession concerns roared. The stock market slumped. Tech companies announced layoffs. The Federal Reserve stopped shooting, and recently announced it's more likely to cut rates in 2024 than raise them.

FARM LOANS AVERAGE 8% INTEREST RATE

The Federal Reserve sets a range for the fed funds rate, which is the rate banks charge each other on what they borrow to meet their overnight capital requirements. The prime rate, a benchmark for business and consumer loans, is usually higher than the fed funds rate and reserved for only the strongest borrowers. Rates get higher as loan risk rises.

Rates on ag loans tend to be higher than prime, and the Federal Reserve Bank of Kansas City reports the average interest rate on all types of farm loans topped 8% in 2023, the highest in 20 years. Rates have climbed for eight consecutive quarters.

Farmers who rely on operating notes and those looking to finance equipment are feeling the sting of higher interest rates the most. After more than a decade of interest rates near zero, farmers had to manage the cost of money alongside running the farm and, in some cases, the interest on the operating line cost as much as seed in 2023.

Many are taking advantage of vendor financing offers, where an input supplier provides credit, often at a discounted interest rate. Others chose to forgo buying new equipment and wait for a better rate.

LAND MARKET STANDS GROUND

Higher interest rates have had a more nuanced role in the land markets. So much of the land is owned outright -- it's about 84% in Iowa -- or was financed at very low interest rates during the past decade that the impact of higher rates is only being felt in new loans.

Conventional wisdom would suggest higher interest rates would cool buying interest by making mortgages more expensive. However, a tight supply of land for sale means interested buyers need to act or potentially miss a once-in-a-generation chance. After several years of record farm incomes, farmers can usually rally resources and may be willing to take higher rate loans now with plans to refinance when they can.

Investors may not be as willing. With 5-year returns on CDs topping 5% this year, there were more lucrative ways to earn money than cash rent. But deposits don't appreciate, and as the adage says, God isn't making any more land.

While interest rates are only one factor influencing farmland values, most experts and surveys show prices continued to rise in 2023 and are likely to remain steady or decline in 2024.